Working Paper: NBER ID: w12405
Authors: Troy Davig; Eric M. Leeper
Abstract: 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: Threshold Switching; Taylor Rule; Asymmetry; Preemptive Policy
JEL Codes: E31; E32; E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Expectations formation effects generated by the possibility of regime change (D84) | Economic outcomes (F69) |
| Expectations formation effects generated by the possibility of regime change (D84) | Current inflation (E31) |
| Expectations formation effects generated by the possibility of regime change (D84) | Output (Y10) |
| Preemptive policy actions by central banks (E52) | Reduction in the volatility of inflation (E31) |
| Symmetric shocks (E32) | Asymmetric effects on the economy (F69) |
| Preemptive policy behavior (E60) | Effectiveness of monetary policy actions (E52) |
| Preemptive policy behavior (E60) | Stabilization of output (E63) |
| Preemptive policy behavior (E60) | Stabilization of inflation (E63) |