Monetary policy regimes and beliefs

Abstract

This paper investigates the role of beliefs over monetary policy in propagating the effects of monetary policy within the context of a dynamic, stochastic general equilibrium model. In our model, monetary policy periodically switches between low and high money growth regimes. When individuals are unable to directly observe the current regime, they will assign some probability to the low money growth, low inflation regime base don observed money growth rates. We show that for an empirically relevant money growth process, beliefs evolve slowly in the wake of a regime change. As a result, our model is able to capture some of the observed persistence of real and nominal variables following such a regime change.