Working Paper

Monetary policy in a Markov-switching VECM: implications for the cost of disinflation and the price puzzle

Abstract: Monetary policy VARs typically presume stability of the long-run outcomes. We introduce the possibility of switches in the long-run equilibrium in a cointegrated VAR by allowing both the covariance matrix and weighting matrix in the error-correction term to switch. We find that monetary policy alternates between sustaining long-run growth and disinflationary regimes. Allowing state changes can also help explain the price puzzle and justify the use of commodity prices as a corrective measure. Finally, we show that regime-switching has implications for disinflationary monetary policy and can explain the variety of sacrifice ratio estimates that exist in the literature.

Status: Published in Journal of Business and Economic Statistics, July 2005, 23(3), pp. 305-13

Bibliographic Information

Provider: Federal Reserve Bank of St. Louis

Part of Series: Working Papers

Publication Date: 2004

Number: 2003-001