Indeterminacy in a Forward Looking Regime Switching Model
This paper is about the properties of Markov switching rational expectations (MSRE) models. We present a simple monetary policy model that switches between two regimes with known transition probabilities. The first regime, treated in isolation, has a unique determinate rational expectations equilibrium and the second contains a set of indeterminate sunspot equilibria. We show that the Markov switching model, which randomizes between these two regimes, may contain a continuum of indeterminate equilibria. We provide examples of stationary sunspot equilibria and bounded sunspot equilibria which exist even when the MSRE model satisfies a 'generalized Taylor principle'. Our result suggests that it may be more difficult to rule out non-fundamental equilibria in MRSE models than in the single regime case where the Taylor principle is known to guarantee local uniqueness.
We thank Troy Davig, Jordi GalÂ--i, Eric Leeper, Julio Rotemberg, Tom Sargent, Chris Sims, Lars Svensson, Eric Swanson, Noah Williams and Michael Woodford for helpful discussions. The views expressed herein do not necessarily reflect those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Farmer acknowledges the support of NSF grant #SES 0418074. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.
Roger E. A. Farmer & Daniel F. Waggoner & Tao Zha, 2009. "Indeterminacy in a forward-looking regime switching model," International Journal of Economic Theory, The International Society for Economic Theory, vol. 5(1), pages 69-84. citation courtesy of