Taylor-type rules versus optimal policy in a
Markov-Switching economy *
Fernando Alexandre} Pedro Bacao ^ and Vasco Gabriel §
April 28, 2008
Abstract
We analyse the effect of uncertainty concerning the state and the nature of asset
price movements on the optimal monetary policy response. Uncertainty is modelled
by adding Markov-switching shocks to a DSGE model with capital accumulation. In
our analysis we consider both Taylor-type rules and optimal policy. Taylor rules have
been shown to provide a good description of US monetary policy. Deviations from
its implied interest rates have been associated with risks of financial disruptions.
Whereas interest rates in Taylor-type rules respond to a small subset of information,
optimal policy considers all state variables and shocks. Our results suggest that,
when a bubble bursts, the Taylor rule fails to achieve a soft landing, contrary to the
optimal policy.
JEL Classification: E52, E58.
Keywords: Asset Prices, Monetary Policy, Markov Switching.
* The authors are grateful to participants in seminars at the Portuguese Catholic
University (Porto) and at the University of Minho, in particular to Francisco Veiga, Luis
Aguiar-Conraria and Ricardo Sousa.
tNIPE and University of Minho. Address: Department of Economics, University of
Minho, 4710-057 Braga, Portugal.
*GEMF and Faculty of Economics of the University of Coimbra. Address: Faculdade de
Economia da Universidade de Coimbra, Av. Dias da Silva 165, 3004-512 Coimbra, Portugal.
§ NIPE and University of Surrey. Address: Department of Economics, University of
Surrey, Guildford, Surrey, GU2 7XH, UK.
More intriguing information
1. AN IMPROVED 2D OPTICAL FLOW SENSOR FOR MOTION SEGMENTATION2. The name is absent
3. The name is absent
4. Implementation of a 3GPP LTE Turbo Decoder Accelerator on GPU
5. Integrating the Structural Auction Approach and Traditional Measures of Market Power
6. ‘I’m so much more myself now, coming back to work’ - working class mothers, paid work and childcare.
7. Tissue Tracking Imaging for Identifying the Origin of Idiopathic Ventricular Arrhythmias: A New Role of Cardiac Ultrasound in Electrophysiology
8. The name is absent
9. Parent child interaction in Nigerian families: conversation analysis, context and culture
10. The name is absent