Sources of macroeconomic fluctuations : a regime-switching DSGE approach

We examine the sources of macroeconomic fluctuations by estimating a variety of richly parameterized DSGE models within a unified framework that incorpo- rates regime switching both in shock variances and in the inflation target. We propose an efficient methodology for estimating regime-switching DSGE mod- els. 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 ev- idence that a shock to the capital depreciation rate, which resembles a financial shock, plays a crucial role in accounting for macroeconomic fluctuations.