We thank a referee and Jose-Victor Rios-Rull (the editor) for many thoughtful comments, and Craig Burnside, Larry Christiano, Tim Cogley, Chris Erceg, Marco Del Negro, Wouter Den Haan, Martin Ellison, Jesus Fernandez-Villaverde, Jordi Gali, Marc Giannoni, Michael Golosov, Pat Higgins, Alejandro Justiniano, Soyoung Kim, Junior Maih, Christian Matthes, Ulrich Müeller, Andy Levin, Lee Ohanian, Pietro F. Peretto, Giorgio Primiceri, Frank Schorfheide, Chris Sims, Harald Uhlig, and seminar participants at the Bank of Korea, NBER summer institute, UC Berkeley, SED, and Duke University for helpful discussions and comments. Eric Wang provided valuable assistance in grid computing. The current version of this paper stems from the two previous unpublished manuscripts, “Sources of the Great Moderation: Shocks, Frictions, or Monetary Policy” and “Has the Federal Reserve's Inflation Target Changed?” The views expressed herein are those of the authors and do not necessarily reflect the views of the Federal Reserve Banks of Atlanta and San Francisco or the Federal Reserve System.
Sources of macroeconomic fluctuations: A regime-switching DSGE approach
Version of Record online: 19 JUL 2011
Copyright © 2011 Zheng Liu, Daniel F. Waggoner, and Tao Zha
Volume 2, Issue 2, pages 251–301, July 2011
How to Cite
Liu, Z., Waggoner, D. F. and Zha, T. (2011), Sources of macroeconomic fluctuations: A regime-switching DSGE approach. Quantitative Economics, 2: 251–301. doi: 10.3982/QE71
- Issue online: 19 JUL 2011
- Version of Record online: 19 JUL 2011
- Submitted April, 2010. Final version accepted May, 2011.
- Regime switch;
- depreciation shock;
- financial shock;
- Müeller method;
- volatility changes;
- inflation target
We examine the sources of macroeconomic fluctuations by estimating a variety of richly parameterized DSGE models within a unified framework that incorporates regime switching both in shock variances and in the inflation target. We propose an efficient methodology for estimating regime-switching DSGE models. Our counterfactual exercises show that changes in the inflation target are not the main driving force of high inflation in the 1970s. The model that best fits the U.S. time-series data is the one with synchronized shifts in shock variances across two regimes, and the fit does not rely on strong nominal rigidities. We provide evidence that a shock to the capital depreciation rate, which resembles a financial shock, plays a crucial role in accounting for macroeconomic fluctuations.