by: Andrew Foerster and Jason Choi
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RWP 16-07, August 2016

Given regime switches in the economy’s growth rate, optimal monetary policy rules may respond by switching policy parameters. These optimized parameters differ across regimes and from the optimal choice under fixed regimes, particularly in the inflation target and interest rate inertia. Optimal switching rules produce welfare gains relative to constant rules, with switches in the implicit real interest rate used for policy and the degree of interest rate inertia producing the largest gains. However, gains from switching rules decrease if the monetary authority trades-off the probability of low rates, or if it may misidentify the regime.

JEL Classification: C63, E31, E52

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