Working Paper: NBER ID: w12965
Authors: Roger E. A. Farmer; Daniel F. Waggoner; Tao Zha
Abstract: This paper studies a New-Keynesian model in which monetary policy may switch between regimes. We derive sufficient conditions for indeterminacy that are easy to implement and we show that the necessary and sufficient condition for determinacy, provided by Davig and Leeper, is necessary but not sufficient. More importantly, we use a two-regime model to show that indeterminacy in a passive regime may spill over to an active regime, no matter how active the latter regime is. As a result, a passive monetary policy is more damaging than has been previously thought. Our results imply that the propagation of shocks in an active regime, such as that of the Federal Reserve in the post-1982 period, may be substantially affected by the possibility of a return to a passive regime of the kind that was followed in the 1960s and 1970s.
Keywords: Markov-switching; New Keynesian model
JEL Codes: E3; E5; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Passive monetary policy regime (E63) | Active monetary policy regime effectiveness (E63) |
| Indeterminacy in passive regime (E63) | Spillover into active regime (E63) |
| High probability of passive regime (E63) | Preventing inflation hawk from restoring determinacy in active regime (E63) |
| Passive regime characteristics (P26) | Active regime outcomes (P27) |