Characterizing Markov-Switching Rational Expectations Models

42 Pages Posted: 5 Sep 2009 Last revised: 22 Jan 2014

See all articles by Seonghoon Cho

Seonghoon Cho

School of Economics, Yonsei University

Date Written: January 22, 2014

Abstract

Markov-switching rational expectations (MSRE) models can yield fresh insights beyond what linear rational expectations (LRE) models have done for macroeconomics, as Davig and Leeper (2007) and Farmer, Waggoner and Zha (2009), among others, have noted and predicted. A lack of tractable methodological foundations, however, may have hindered researchers from uncovering the salient features of MSRE models. This study improves the status quo to a level at which MSRE models can be analyzed as easily and comprehensively as LRE models. Specifically, we provide the conditions for determinacy and indeterminacy in the mean-square stability sense as well as a solution method to general MSRE models. These tasks are accomplished by applying the standard forward method without reference to the eigensystem of a MSRE model, which is unknown due to its inherent nonlinearity. We apply our methodology to a New-Keynesian model subject to regime-switching in monetary policy and find some unforeseen but intuitive determinacy results. Markov-switching in the private sector is also shown to deliver potentially rich dynamics.

Keywords: Markov-Switching, Mean-square Stability, Determinacy, Forward Method, No-bubble Condition

JEL Classification: C61, C62, D84, E42

Suggested Citation

Cho, Seonghoon, Characterizing Markov-Switching Rational Expectations Models (January 22, 2014). Available at SSRN: https://ssrn.com/abstract=1468331 or http://dx.doi.org/10.2139/ssrn.1468331

Seonghoon Cho (Contact Author)

School of Economics, Yonsei University ( email )

Yonsei University
Seoul
Korea
82-2-2123-2470 (Phone)
82-2-393-1158 (Fax)

HOME PAGE: http://web.yonsei.ac.kr/sc719/index.htm

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