Optimal Monetary Policy Regime Switches

40 Pages Posted: 19 Aug 2016

See all articles by Jason Choi

Jason Choi

Federal Reserve Bank of Kansas City

Andrew T. Foerster

Federal Reserve Banks - Federal Reserve Bank of San Francisco

Date Written: August 11, 2016

Abstract

Given regime switches in the economy’s growth rate, optimal monetary policy rules may respond by switching policy parameters. These optimized parameters differ across regimes and from the optimal choice under fixed regimes, particularly in the inflation target and interest rate inertia. Optimal switching rules produce welfare gains relative to constant rules, with switches in the implicit real interest rate used for policy and the degree of interest rate inertia producing the largest gains. However, gains from switching rules decrease if the monetary authority trades-off the probability of low rates, or if it may misidentify the regime.

Keywords: Growth Rate, Optimal Policy, Regime Switching, Taylor Rule, Inflation Target

JEL Classification: C63, E31, E52

Suggested Citation

Choi, Jason and Foerster, Andrew T., Optimal Monetary Policy Regime Switches (August 11, 2016). Federal Reserve Bank of Kansas City Working Paper No. 16-07. Available at SSRN: https://ssrn.com/abstract=2824656

Jason Choi

Federal Reserve Bank of Kansas City ( email )

1 Memorial Dr.
Kansas City, MO 64198
United States

Andrew T. Foerster (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of San Francisco ( email )

101 Market Street
San Francisco, CA 94105
United States

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