Monetary Policy Rules and Regime Shifts
26 Pages Posted: 21 Jul 2002
Date Written: June 2002
A growing body of empirical literature has established interest rate rules as a convenient way to model and interpret monetary policy. However, as pointed out by Rudebusch (1998), vector autoregression (VAR) models used to recover the central banks' reaction functions generally rely on the dubious assumptions of linearity and time invariance. This paper proposes an empirical framework which allows the parameters of an interest rate rule to vary over time allowing for multiple regime shifts. Employing Markov-switching VAR models we are able to identify significant and persistent shifts which affects the dynamics of the central banks' instrument interest rates. The shifts are mainly driven by discrete changes in inflation targets.
Keywords: vector autoregression, regime switching, Taylor rule
JEL Classification: E58, C22, C51
Suggested Citation: Suggested Citation