Evolving Macroeconomic Dynamics in a Small Open Economy: An Estimated Markov Switching DSGE Model for the UK

This paper investigates the possibility of shifts in the UK economy using a Markov switching open economy dynamic stochastic general equilibrium (DSGE) model. We find overwhelming evidence to reject the hypothesis that the deep structural parameters of the underlying structural model had stayed constant throughout the sample period and there is significant changes to the volatility of the structural shocks. Counterfactual experiments based on the model with the best empirical fit indicate that the change in the policy rule as well as changes to the volatility of the structural shocks over the sample period are crucial features in explaining UK's macroeconomic performance.