Monetary Regime Change and Business Cycles

This paper proposes a simple method to structurally estimate a model over a period of time containing a regime shift. It then evaluates to which degree it is relevant to explicitly acknowledge the break in the estimation procedure. We apply our method on Swedish data, and estimate a DSGE model explicitly taking into account the monetary regime change in 1993, from exchange rate targeting to inflation targeting. We show that ignoring the break in the estimation leads to spurious estimates of model parameters including parameters in both policy and non-policy economic relations. Accounting for the regime change suggests that monetary policy reacted strongly to exchange rate movements in the first regime, and mostly to inflation in the second. The sources of business cycle fluctuations and their transmission mechanism are significantly affected by the exchange rate regime.