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

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 linking the switching of the Taylor rule coefficients to the switching of the coefficients of an auxiliary uncensored Markov-switching regressio...

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Published inJournal of money, credit and banking Vol. 50; no. 1; pp. 115 - 154
Main Author GONZALEZ-ASTUDILLO, MANUEL
Format Journal Article
LanguageEnglish
Published Columbus Wiley Subscription Services 01.02.2018
Ohio State University Press
Subjects
C34
E52
E63
Economic models
Fiscal policy
Inflation
Interdependence
Interest rates
Markov analysis
Markov‐switching coefficients
Monetary policy
monetary–fiscal policy interactions
Stabilization
zero lower bound
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ISSN0022-2879
1538-4616
DOI10.1111/jmcb.12455

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Summary: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 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 because of the presence of the zero lower bound. Using a Markov-switching fiscal policy rule as the auxiliary regression, I apply the estimation technique to U.S. data. Results show evidence of monetary and fiscal policy comovements, with monetary policy reacting weakly to inflation when fiscal policy is focused on real activity as opposed to debt stabilization, and vice versa.
Bibliography:The views expressed in this paper are solely the responsibility of the author and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System. I thank John Roberts and Damjan Pfajfar for offering feedback on this project. Two anonymous referees also offered valuable suggestions to improve this paper.
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ISSN:0022-2879
1538-4616
DOI:10.1111/jmcb.12455