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Markov switching monetary policy in a two-country DSGE model
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Mavromatis, Konstantinos (2012) Markov switching monetary policy in a two-country DSGE model. Working Paper. Coventry: Department of Economics, University of Warwick. The Warwick Economics Research Paper Series (TWERPS) (Number 982). (Unpublished)
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Text (Working paper)
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Official URL: http://www2.warwick.ac.uk/fac/soc/economics/resear...
Abstract
In this paper I show, using both empirical and theoretical analysis, that changes in monetary policy in one country can have important effects on other economies. My new empirical evidence shows that changes in the monetary policy behaviour of the Fed since the start of the Euro, well captured by a Markov-switching Taylor rule, have had significant effects on the behaviour of inflation and output in the Eurozone even though ECB's monetary policy is found to be fairly stable. Using a two-country DSGE model, I examine this case theoretically; monetary policy in one of the countries (labelled foreign) switches regimes according to a Markov-switching process and this has non-negligible effects in the other (home) country. Switching by the foreign central bank renders commitment to a time invariant interest rate rule suboptimal for the home central bank. This is because home agents expectations change as foreign monetary policy changes which affects the dynamics of home inflation and output. Optimal policy in the home country instead reacts to the regime of the foreign monetary policy and so implies a time-varying reaction of the home Central Bank. Following this time-varying optimal policy at home eliminates the effects in the home country of foreign regime shifts, and also reduces dramatically the effects in the foreign country. Therefore, changes in foreign monetary regimes should not be neglected in considering monetary policy at home.
Item Type: | Working or Discussion Paper (Working Paper) | ||||
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Alternative Title: | |||||
Subjects: | H Social Sciences > HB Economic Theory H Social Sciences > HG Finance |
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Divisions: | Faculty of Social Sciences > Economics | ||||
Library of Congress Subject Headings (LCSH): | Economic policy, Monetary policy, Economics -- Mathematical models , Markov processes | ||||
Series Name: | The Warwick Economics Research Paper Series (TWERPS) | ||||
Publisher: | Department of Economics, University of Warwick | ||||
Place of Publication: | Coventry | ||||
Official Date: | 2012 | ||||
Dates: |
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Number: | Number 982 | ||||
Number of Pages: | 34 | ||||
Status: | Not Peer Reviewed | ||||
Publication Status: | Unpublished | ||||
Access rights to Published version: | Open Access (Creative Commons) |
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