Working Paper

Identifying the Stance of Monetary Policy at the Zero Lower Bound: A Markov-switching Estimation Exploiting Monetary-Fiscal Policy Interdependence

Abstract: In this paper, I propose an econometric technique to estimate a Markov-switching Taylor rule subject to the zero lower bound of interest rates. I show that incorporating a Tobit-like specification allows to obtain consistent estimators. More importantly, I show that linking the switching of the Taylor rule coefficients to the switching of the coefficients of an auxiliary uncensored Markov-switching regression improves the identification of an otherwise unidentifiable prevalent monetary regime. To illustrate the proposed estimation technique, I use U.S. quarterly data spanning 1960:1-2013:4. The chosen auxiliary Markov-switching regression is a fiscal policy rule where federal revenues react to debt and the output gap. Results show that there is evidence of policy co-movements with debt-stabilizing fiscal policy more likely accompanying active monetary policy, and vice versa.

Keywords: Markov-switching coefficients; zero lower bound; monetary-fiscal policy interactions;

JEL Classification: C34; E52; E63;

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 2014-09-19

Number: 2014-97

Pages: 32 pages