Evolving macroeconomic dynamics in a small open economy: an estimated Markov-switching DSGE model for the United Kingdom

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Published on 27 July 2010

Working Paper No. 397
By Philip Liu and Haroon Mumtaz 

This paper carries out a systematic investigation into the possibility of structural shifts in the UK economy using a Markov-switching dynamic stochastic general equilibrium (DSGE) model. We find strong evidence for shifts in the structural parameters of several equations of the DSGE model. In addition, our results indicate that the volatility of structural shocks has also changed over time. However, a version of the model that allows for a change in the coefficients of the Taylor rule and shock volatilities provides the best model fit. Estimates from the selected DSGE model suggest that the mid-1970s were associated with a regime characterised by a smaller reaction by the monetary authorities to inflation developments.

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