Working Paper: NBER ID: w12540
Authors: Roger E. A. Farmer; Daniel F. Waggoner; Tao Zha
Abstract: This paper is about the properties of Markov switching rational expectations (MSRE) models. We present a simple monetary policy model that switches between two regimes with known transition probabilities. The first regime, treated in isolation, has a unique determinate rational expectations equilibrium and the second contains a set of indeterminate sunspot equilibria. We show that the Markov switching model, which randomizes between these two regimes, may contain a continuum of indeterminate equilibria. We provide examples of stationary sunspot equilibria and bounded sunspot equilibria which exist even when the MSRE model satisfies a 'generalized Taylor principle'. Our result suggests that it may be more difficult to rule out non-fundamental equilibria in MRSE models than in the single regime case where the Taylor principle is known to guarantee local uniqueness.
Keywords: policy rule; inflation; serial dependence; multiple equilibria; regime switching
JEL Codes: E31; E4; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Monetary policy rules (E52) | Uniqueness of equilibria (C62) |
| First regime (P30) | Unique determinate rational expectations equilibrium (C62) |
| Second regime (P30) | Indeterminate sunspot equilibria (C62) |
| Transition between regimes (P39) | Continuum of indeterminate equilibria (D59) |
| Generalized Taylor principle (C61) | Non-fundamental equilibria (D59) |
| Stationary sunspot equilibria (D50) | Existence under generalized Taylor principle (C62) |