Monetary Policy Rules and Regime Shifts

26 Pages Posted: 21 Jul 2002

See all articles by Giorgio Valente

Giorgio Valente

Hong Kong Institute for Monetary and Financial Research (HKIMR)

Date Written: June 2002

Abstract

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

Valente, Giorgio, Monetary Policy Rules and Regime Shifts (June 2002). Available at SSRN: https://ssrn.com/abstract=317324 or http://dx.doi.org/10.2139/ssrn.317324

Giorgio Valente (Contact Author)

Hong Kong Institute for Monetary and Financial Research (HKIMR) ( email )

One Pacific Place, 10th Floor
88 Queensway
Hong Kong
China

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