Asymmetric Expectation Effects of Regime Shifts in Monetary Policy

Authors

Daniel F. Waggoner

Tao Zha

Download PDF
(661 KB)

2008-22 | September 1, 2008

This paper addresses two substantive issues: (1) Does the magnitude of the expectation effect of regime switching in monetary policy depend on a particular policy regime? (2) Under which regime is the expectation effect quantitatively important? Using two canonical DSGE models, we show that there exists asymmetry in the expectation effect across regimes. The expectation effect under the dovish policy regime is quantitatively more important than that under the hawkish regime. These results suggest that the possibility of regime shifts in monetary policy can have important effects on rational agents’ expectation formation and on equilibrium dynamics. They offer a theoretical explanation for the empirical possibility that a policy shift from the dovish regime to the hawkish regime may not be the main source of substantial reductions in the volatilities of inflation and output.

About the Authors
Zheng Liu is a vice president and director of the Center for Pacific Basin Studies in the Economic Research Department of the Federal Reserve Bank of San Francisco. Learn more about Zheng Liu