International Finance Discussion Papers (IFDP)

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November 2011

Monetary Regime Switches and Unstable Objectives

Davide Debortoli and Ricardo Nunes

Abstract:

Monetary policy objectives and targets are not necessarily stable over time. The regime switching literature has typically analyzed and interpreted changes in policymakers' behavior through simple interest rate rules. This paper analyzes policy regime switches explicitly modeling policymakers' behavior and objectives. We show how current monetary policy is affected and should optimally respond to alternative regimes. We also show that changes in the parameters of simple rules do not necessarily correspond to changes in policymakers' preferences. In fact, capturing and interpreting regime changes in preferences through interest rate rules can lead to misleading results.

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Keywords: Monetary policy, regime switches, unstable objectives

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Last Update: July 10, 2020