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Estimating the FOMC’s interest rate rule with variable selection and partial regime switching

Published online by Cambridge University Press:  24 August 2021

Adam Check
Adam Check*
Affiliation:
University of St. Thomas, St Paul, MN 55105, USA
*
Email: ajc@stthomas.edu.
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Abstract

When studying the Federal Open Market Committee’s (FOMC’s) interest rate rule, some authors, such as Gonzalez-Astudillo [(2018) Journal of Monetary, Credit, and Banking 50(1), 115–154.], find evidence for changes in inflation and output gap responses. Others, such as Sims and Zha [(2006) American Economic Review 96(1), 54–81.], only find evidence for a change in the variance of the interest rate rule. In this paper, I develop a new two-regime Markov-switching model that probabilistically performs variable selection and identification of parameter change for each variable in the model. I find substantial evidence that there have been changes in the FOMC’s response to the unemployment gap and in the volatility of the rule. When the FOMC responds strongly to the unemployment gap, I find a bimodal density for the inflation response coefficient. Despite the bimodal density, there is a low probability that there have been changes in the FOMC’s response to inflation.

Keywords

Monetary policyinterest rate ruleMarkov switchingmodel averagingC22C24C51C52E52
Type
Articles
Information
Macroeconomic Dynamics , Volume 27 , Issue 2 , March 2023 , pp. 297 - 330
Copyright
© The Author(s), 2021. Published by Cambridge University Press

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