36 Pages Posted: 28 Sep 2006
Date Written: August 28, 2006
This paper makes changes in monetary policy rules (or regimes) endogenous. Changes are triggered when certain endogenous variables cross specified thresholds. Rational expectations equilibria are examined in three models of threshold switching to illustrate that (i) expectations formation effects generated by the possibility of regime change can be quantitatively important; (ii) symmetric shocks can have asymmetric effects; (iii) endogenous switching is a natural way to formally model preemptive policy actions. In a conventional calibrated model, preemptive policy shifts agents' expectations, enhancing the ability of policy to offset demand shocks; this yields a quantitatively significant "preemption dividend."
Keywords: Markov switching, Taylor rule, expectations formation
JEL Classification: E31, E32, E52, E58
Suggested Citation: Suggested Citation
Davig, Troy and Leeper, Eric M., Endogenous Monetary Policy Regime Change (August 28, 2006). CAEPR Working Paper No. 2006-002. Available at SSRN: https://ssrn.com/abstract=932673 or http://dx.doi.org/10.2139/ssrn.932673