Realized and Optimal Monetary Policy Rules in an Estimated Markov-Switching DSGE Model of the United Kingdom

Abstract

This paper investigates underlying changes in the UK economy over the past thirty-five years using a small open economy DSGE model. Using Bayesian analysis, wefind UK monetary policy, nominal price rigidity and exogenous shocks, are all subject to regime shifting. A model incorporating these changes is used to estimate the realised monetary policy and derive the optimal monetary policy for the UK. This allows us to assess the effectiveness of the realised policy in terms of stabilising economic fluctuations, and, in turn, provide an indication of whether there is room for monetary authorities to further improve their policies.