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Research Working Paper |
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Monetary Policy Regime Shifts and Inflation Persistence By Troy Davig and Taeyoung Doh Abstract Using Bayesian methods, we
estimate a Markov-switching New Keynesian (MSNK) model that allows shifts in the monetary policy
reaction coefficients and shock volatilities. Using U.S. data, we find that a more-aggressive monetary
policy regime was in place after the Volcker disinflation and before 1970 than during the Great
Inflation of the 1970s. Our estimates also indicate that a low-volatility regime has been in place
during most of the sample period after 1984. We connect the timing of the different regimes to a
measure of inflation persistence. In the MSNK model, the population moment describing the serial
correlation of inflation is a weighted average of the autocorrelation parameters of the exogenous
shocks. A shift to an aggressive monetary regime or a low-volatility regime shuffles the weight from
the more-persistent to the less-persistent shocks, resulting in a decline in inflation persistence.
The timing of regimes from the estimated MSNK model generates a statistically significant
'low-high-low' pattern of inflation persistence that is consistent with reduced-form empirical models.
We discuss relative importance of policy shifts and volatility shifts in explaining this pattern. |