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Evolving Macroeconomic Dynamics in a Small Open Economy: An Estimated Markov Switching DSGE Model for the UK


  • The authors thank the editor, Paul Evans, and an anonymous referee for their comments that have helped improve the paper. We also would like to thank Francesco Bianchi for his advice on model solution and participants at the Bank of England and the Reserve Bank of New Zealand seminars for useful comments. The paper does not reflect the views of the Bank of England or the International Monetary Fund.


This paper investigates the possibility of shifts in the UK economy using a Markov switching open economy dynamic stochastic general equilibrium (DSGE) model. We find overwhelming evidence to reject the hypothesis that the deep structural parameters of the underlying structural model had stayed constant throughout the sample period and there is significant changes to the volatility of the structural shocks. Counterfactual experiments based on the model with the best empirical fit indicate that the change in the policy rule as well as changes to the volatility of the structural shocks over the sample period are crucial features in explaining UK’s macroeconomic performance.