A Time-Varying Parameter Structural Model of the UK Economy

• Authors: Katerina Petrova.
• DSGE models
• time varying parameters
• open economy
• UK economy
• Journal of Economic Dynamics and Control
• Econometrics and Quantitative Methods

We estimate a time-varying parameter structural macroeconomic model of the UK economy, using a Bayesian local likelihood methodology. This enables us to estimate a large open-economy DSGE model over a sample that comprises several different monetary policy regimes and an incomplete set of data. Our estimation identifies a gradual shift to a monetary policy regime characterised by an increased responsiveness of policy towards inflation alongside a decrease in the inflation trend down to the two percent target level. The time-varying model also performs remarkably well in forecasting and delivers statistically significant accuracy improvements for most variables and horizons for both point and density forecasts compared to the standard fixed-parameter version.