Publication

This paper assesses the quantitative importance of expectation effects of regime shifts in monetary policy in a DSGE model that allows the monetary policy rule to switch between a 'bad' regime and a 'good' regime. The authors argue that when agents take into account such regime shifts in forming expectations, the expectation effect is asymmetric. The authors find that although the expectation effect dampens aggregate fluctuations in the bad regime, a switch from the bad regime to the good regime can still substantially reduce the volatility of both inflation and output, provided that they allow some 'reduced-form' parameters in the private sector to change with monetary policy regime.