Title: Credit cycles and inflation targeting in a regime switching model
Authors: Willi Semmler - New School for Social Research (United States) [presenting]
Timm Faulwasser - Karlsruhe Institute of Technology (Germany)
Marco Gross - European Central Bank (Germany)
Abstract: A macro monetary policy model with double switching, one for the inflation and another one for the credit dynamics, is presented. We include in an Svensson's type inflation targeting model a nonlinear Phillips curve defining a state dependence of the inflation rate and add a dynamic equation for a state dependence of credit flows and credit spreads. As to the latter, we follow up the Minsky hypothesis that booms sow the seeds of the next crisis, in the sense that in credit expansions credit spreads are low and in contractions credit spreads are high. As to policies, we explore in a finite horizon monetary policy model the dynamic effects of price oriented as well as credit volume oriented monetary policy variants. This allows us to study stabilizing - destabilizing effects of price and non-price (credit volume) drivers of output gap, inflation and credit flows, in the context of our model. Empirically we are using a multi regime GVAR model to explore the double switching dynamics using Euro area data. We can demonstrate that in fact empirically, using EU data, both the output gap dynamics and the credit dynamics undergo regime switches. Moreover, the impulse-responses are explored using MRGVAR showing that the results are similar as predicted in the theoretical model.