Title: Origins of macro policy shifts: A new approach to regime switching in DSGE models
Authors: Boreum Kwak - Martin Luther University Halle-Wittenberg and Halle Institute for Economic Research (Germany) [presenting]
Yoosoon Chang - Indiana University (United States)
Bing Li - Tsinghua University (China)
Fei Tan - Saint Louis University (United States)
Abstract: The origins of aggregate fluctuations in the U.S. data are investigated by using Bayesian analysis of a New-Keynesian DSGE model with monetary-fiscal policy interactions. We introduce regime switching into the model that links the current regime of the economy to the past structural shocks by an autoregressive regime factor. Using a simple analytical model, such linkage is shown to generate endogenous feedback from the behavior of underlying economic fundamentals to the regime generating process. Our key empirical findings are twofold. First, non-policy shocks, most notably the markup shock, have played a predominant role in driving regime changes during the post-World War II era. Second, the Bayes factor strongly favors the endogenous switching version of the model over the exogenous case. We conclude that endogenizing regime changes in DSGE models with monetary-fiscal policy interaction provides both a theoretically and empirically promising venue for understanding the purposeful nature of policy interaction.