Solving linear rational expectations models in the presence of structural change: Some refinements

Abstract

Standard solution methods for linear rational expectations models assume a time-invariant structure. Recent work has gone beyond this by formulating solution methods for linear rational expectations models subject to structural changes, such as parameter shifts and policy reforms, that are announced in advance. This paper contributes to this literature by presenting a backward recursive solution method that is fast, general and easy to use: the only technical requirement is that the user `write down' the structural matrices in each regime; the solution is then found recursively using these matrices. I provide a series of examples and show how the method can deal with some important structural changes - such as imperfectly credible policy reforms and shifts to multiple equilibria (sunspots) - that received little attention in recent literature.