Changes in nominal rigidities in Poland – a regime switching DSGE perspective

By Paweł Baranowski and Zbigniew Kuchta

http://d.repec.org/n?u=RePEc:pra:mprapa:70573&r=dge

We estimate a dynamic stochastic general equilibrium model that allows for regimes Markov switching (MS-DSGE). Existing MS-DSGE papers for the United States focus on changes in monetary policy or shocks volatility, contributing the debate on the Great Moderation and/or Volcker disinflation. However, Poland which here serves as an example of a transition country, faced a wider range of structural changes, including long disinflation, EU accession or tax changes. The model identifies high and low rigidity regimes, with the timing consistent with menu cost explanation of nominal rigidities. Estimated timing of the regimes captures the European Union accession and indirect tax changes. The Bayesian model comparison results suggest that model with switching in both analyzed rigidities is strongly favored by the data in comparison with switching only in prices or in wages. Moreover, we find significant evidence in support of independent Markov chains.

We all know price rigidities à la Calvo are a really bad idea when there are major changes in the economic environment. They impose a fixed probability of prices changing even when, say, inflation or market conditions change. This paper looks whether there are been such rigidity changes in Poland, an economy that went through fairly dramatic structural changes. And yes, it turns out the rigidity parameter does change. Unfortunately, it is only modeled as a Markov-switching process, thus not allowing for rigidity to be state-dependent. That could have allowed to figure out what makes rigidity adapt: is it market competition, inflation, or tax treatment? That could have been a really great insight.