This thesis presents the potential opportunities of global asset allocation and the possible enhancement of these opportunities from using a Markov Switching Model. The thesis extends upon previous conditional asset pricing studies in global asset allocation, such as those done by Ilamnen (1995), Harvey, Solnik and Zhou (1992) and Bilson (1993), where expected future returns are forecast based on conditional variables. The finding of these studies, and many others, are combined with the works on Markov Switching models and market segmentation theories to create a uniform structure for analysing regime switching properties in currencies, international equities and international bond markets. This thesis is segregated into 4 major sections. The chapters 1-4 develop a unified framework that is used in the analysis of markets. The chapters 5-7 are focused on currencies, international equities and international bonds. For each market a model is constructed that is based upon the structure proposed by Frankel and Froot (1988). In this model the market is segmented into two groups ?? value based investors and momentum based investors. To replicate this structure, a two regime Markov Switching model is used, where one regime is constructed as a value regime and the second is constructed as a momentum regime. These models are then compared to linear versions of the models, to see whether there is any additional benefit to the application of regime switching methods. In conjunction with testing the potential benefits of the Markov Regime Switching process, this study also investigates the very nature, or characteristics of regime switching in the international markets. This is undertaken though some alternate models and enhancements to see whether there is any predictability, or characterisations can be made of the switching process. To ensure a comprehensive analysis, several analytical methods have been used, including extensive econometric modelling, statistical analysis of forecasts and portfolio back testing. A number of conclusions can be drawn from the results. Firstly it appears that there is substantial evidence of regime switching in international markets, such as that shown in a Frankel-Froot framework. This in turn has major implication for the understanding of the way in which international markets function, and further the empirical evidence supports many of the anecdotal observations of market based participants. Secondly, there appears to be a strong level of economic relevance to the modelling. The models are shown to generate a theoretical economic profit, which shows that the international markets are only semi efficient. Further, forecasts generated from the Markov Switching models outperform the linear counterparts in economic significance in portfolio tests. However, for both equities and bonds, the general accuracy of the forecast tends to be inferior to the linear counterparts. Finally, the nature of regime switching is investigated in detail, particularly in reference to 3 potential drivers ?? greed, fear and success. The evidence shows that these can help explain the characteristics of regime switching, as in some cases potentially adding economic value. However, it seems that success is more important than a broader economic environment.

This thesis presents the potential opportunities of global asset allocation and the possible enhancement of these opportunities from using a Markov Switching Model. The thesis extends upon previous conditional asset pricing studies in global asset allocation, such as those done by Ilamnen (1995), Harvey, Solnik and Zhou (1992) and Bilson (1993), where expected future returns are forecast based on conditional variables. The finding of these studies, and many others, are combined with the works on Markov Switching models and market segmentation theories to create a uniform structure for analysing regime switching properties in currencies, international equities and international bond markets. This thesis is segregated into 4 major sections. The chapters 1-4 develop a unified framework that is used in the analysis of markets. The chapters 5-7 are focused on currencies, international equities and international bonds. For each market a model is constructed that is based upon the structure proposed by Frankel and Froot (1988). In this model the market is segmented into two groups ?? value based investors and momentum based investors. To replicate this structure, a two regime Markov Switching model is used, where one regime is constructed as a value regime and the second is constructed as a momentum regime. These models are then compared to linear versions of the models, to see whether there is any additional benefit to the application of regime switching methods. In conjunction with testing the potential benefits of the Markov Regime Switching process, this study also investigates the very nature, or characteristics of regime switching in the international markets. This is undertaken though some alternate models and enhancements to see whether there is any predictability, or characterisations can be made of the switching process. To ensure a comprehensive analysis, several analytical methods have been used, including extensive econometric modelling, statistical analysis of forecasts and portfolio back testing. A number of conclusions can be drawn from the results. Firstly it appears that there is substantial evidence of regime switching in international markets, such as that shown in a Frankel-Froot framework. This in turn has major implication for the understanding of the way in which international markets function, and further the empirical evidence supports many of the anecdotal observations of market based participants. Secondly, there appears to be a strong level of economic relevance to the modelling. The models are shown to generate a theoretical economic profit, which shows that the international markets are only semi efficient. Further, forecasts generated from the Markov Switching models outperform the linear counterparts in economic significance in portfolio tests. However, for both equities and bonds, the general accuracy of the forecast tends to be inferior to the linear counterparts. Finally, the nature of regime switching is investigated in detail, particularly in reference to 3 potential drivers ?? greed, fear and success. The evidence shows that these can help explain the characteristics of regime switching, as in some cases potentially adding economic value. However, it seems that success is more important than a broader economic environment.

El objetivo principal de la investigación emprendida en la presente tesis doctoral es elaborar una técnica de construcción de un indicador económico compuesto o un conjunto de dichos indicadores que, correspondiendo al concepto teorético del ciclo económico (comercial), permitirán detectar y predecir los puntos de giro del ciclo económico.Como el punto de partida hemos escogido la definición del ciclo económico propuesta por Burns y Mitchell (1946). Según nuestra opinión, el analisis dinámico factorial es el método idóneo para captar los puntos de giro del ciclo económico en el sentido de Burns y Mitchell. Por un lado, tiene en cuenta los movimientos comunes de varias series macroeconómicas que bajan y suben simultaneamente durante las fases de recesiones y expansiones, respectivamente. Por otro lado, refleja las asimetrías que existen entre las dos fases cíclicas, como, por ejemplo, las tasas de crecimiento y la volatilidad distintas durante las recesiones y expansiones. Ambos rasgos estan subrayados por Burns y Mitchell como características definitivas del ciclo económico.El análisis dinámico factorial en su estado actual exige sin duda ciertas modificaciones y algunas extensiones para obtener las estimaciones insesgadas y consistentes de los indicadores económicos compuestos y para utilizar la información disponible de la mejor manera posible.Nuestra investigación está dirigida, en primer lugar, hacia los economistas prácticos que han optado por utilizar el análisis dinámico factorial para la construcción del indicador del ciclo económico tanto a nivél regional como nacional.La tesis esta compuesta por cinco capítulos donde el primer y el último capítulos son, respectivamente, la introducción y la conclusión. En ellos se exponen los objetivos del estudio y los resultados alcanzados en el curso de la investigación.En el capítulo dos describimos varios metodos de análisis de las fluctuaciones económicas que han sido propuestos durante los últimos 20 años. Por un lado, consideramos los modelos con la dinámica nolineal, concretamente el cambio de regímenes o el Markov switching. Por otro lado, examinamos los modelos lineales del análisis dinámico factorial. Al final del capítulo analizamos el modelo del factor común latente con la dinámica nolineal (con cambios de regímenes) que está construido como una combinación de estos dos metodos principales.En el capítulo tres introducimos un modelo general dinámico multifactorial con la dinámica lineal y nolineal. Este modelo permite captar la dimensión intertemporal (indicador avanzado versus indicador coincidente) de los factores comunes inobservables. Se examinan dos modelos dinámicos alternativos con un factor común inobservable avanzado y un factor común inobservable coincidente. En el primer modelo el factor común coincidente esta influido por el factor común avanzado a través del mecanismo de causalidad de Granger. Mientras que en el segundo modelo los dos factores estan relacionados via la matríz de las probabilidades de transición. Debido a que el factor avanzado contiene información sobre los cambios futuros de las fases cíclicas, ambos modelos permiten hacer predicciones de los puntos de giro del ciclo económico.En el capítulo cuatro elaboramos las técnicas sumplementarias necesarias para resolver algunos problemas de datos que son bastante frecuentes en la actividad de un economista empírico. Los dos problemas más importantes son los cambios estructurales y la falta de observaciones, particularmente cuando los datos que estan disponibles con distintas frecuencias (por ejemplo: los datos mensuales y trimestrales). Estos problemas quiebran la continuidad de la serie temporal y reducen el número de observaciones válidas para el análisis estadístico. Se demuestra que estos problemas se resuelven modificando el modelo de análisis dinámico factorial, con lo que se obtienen estimaciones más eficientes de los parametros del modelo. / The main objective of our research undertaken in this thesis is to elaborate a technique of constructing a composite economic indicator or a set of such indicators which would correspond to the theoretical concept of business cycle and reflect a phenomenon which may be interpreted as the cyclical dynamics of the economy.As a point of departure we have chosen the definition of business cycle proposed by Burns and Mitchell (1946). We believe that the most appropriate method to capture the Burns and Mitchell's cycle would be the dynamic factor analysis.The dynamic factor analysis in its current state requires undoubtedly some refinements and extensions to obtain unbiased and consistent estimates of the composite economic indicators and to use the available information in the best possible way.Our research is mostly oriented towards the practitioners who have opted for using the dynamic factor approach in the construction of the business cycle indicator both at the regional and national levels.The thesis is comprised of five chapters where the first and the last chapters are the introduction and conclusion delineating the objectives of the study and summarizing the results achieved during research.Chapter two describes various approaches to the analysis of economic fluctuations proposed during the last 20 years. On the one hand, it concentrates on models with nonlinear, namely Markov-switching, dynamics, on the other hand, it is concerned with dynamic factor models. Finally, it shows the combined techniques which unify these two principal approaches, thus, modeling common latent factor with regime-switching dynamics.In chapter three we introduce a general multifactor dynamic model with linear and regime-switching dynamics. This model allows capturing the intertemporal (leading versus coincident) dimension of the latent common factors. Two alternative multifactor dynamic models with a leading and a coincident unobserved common factors are examined: a model where the common coincident factor is Granger-caused by the common leading factor and a model where the leading relationship is translated into a set of specific restrictions imposed on the transition probabilities matrix.Chapter four concentrates on the supplementary devices which allow to overcome some data problems which are very frequent in the practitioner's life. Among the most prominent are the structural breaks and missing observations. It is shown that some of these troubles can be coped with by modifying the dynamic common factors models, which leads to more efficient estimates of the parameters of the models.

During the business cycle, how the firms' marketing expenses affect the stock returns vary with economy condition. Although prior studies have focused on how change in advertising and research and development (R&D) affect firms during recessions, those studies ignored the interaction between advertising and R&D. Besides, prior studies in the economics field find that the macroeconomics factors will affect firm performance. Therefore, this paper investigates which macroeconomics factor will affect firms spending on advertising and R&D to increase stock return of firms during recessions based on controlling the interaction between advertising and R&D. We match the sample of NYSE-, AMEX-, and NASDAQ-listed firms that are specified as ordinary common shares with monthly returns from the Center for Research in Securities Prices (CRSP) and with advertising and R&D from the yearly merged COMPUSTAT data for 1990 to 2010. In addition, we use the Markov switching model to identify economy condition. Meanwhile we use the portfolio analysis to classify the firms into four portfolios and though the macroeconomic model to discuss which factors impact the excess return. This study finds that controlling the condition of R&D-intensive, the default spread and growth in money supply will both affect high advertising firms, more than low advertising firm in recessions. Moreover, controlling the condition of advertising-intensive, the default spread and growth in money supply will both affect high R&D firms more than low R&D firms in recessions. These consequences may result from that during the recession, the default spread will increase and the same time the investors will not prefer high advertising and R&D firms (risky assets). On the other hand, when government implements expansionary monetary policy, investors will prefer high advertising and R&D firms. In summary, this study discuss how the macroeconomic factors affect the excess return of portfolio during recessions based on controlling the interaction between advertising and R&D. Firms could use these results to improve the performances and increase the stock returns by adjusting their spending on advertising and R&D during recessions.

In this study, we examine how advertising and customer satisfaction affect a firm¡¦s systematic risk (£]-risk) under both the highly volatile and tranquil market. This study extends prior studies that primarily considered the effects of marketing initiatives on performance metrics, focusing on systematic risk under the highly volatile and tranquil market. We examine how advertising and customer satisfaction affect a firm¡¦s £]-risk under the two distinct markets. We develop a two-stage model procedure. First, each individual firm¡¦s £]-risk in the both markets is estimated by Fama-French-Carhart-Ang 5-factor model which includes implied volatility index (VIX) as an aggregate volatility factor, along with the estimators of maximum likelihood (MLE) under the Markov switching model. Second, to examine the impact of advertising and customer satisfaction on £]-risk, we estimate empirical models for the dataset of the two distinct markets by the generalized method of moments (GMM) and the quantile regression. The results significantly support our hypotheses that higher advertising and higher customer satisfaction lower a firm¡¦s £]-risk under the overall, highly volatile and tranquil markets from the standpoint of long run. Furthermore, we find an additional discovering that from the view of short term, adverting is negatively significant associated with £]-risk under the highly volatile market, while customer satisfaction is not. Customer satisfaction, however, is negatively significant associated with £]-risk under the tranquil market, while advertising is not.

This dissertation studies monetary-fiscal policy interactions and adaptive learning applications in regime-switching DSGE models. A common thread through my research is understanding how policymakers may be affected by the interaction of policy regime change and agents' beliefs about past, current or future policy in general equilibrium. The work I present in this dissertation shows that conventional and unconventional policy outcomes, as well as the existence, uniqueness and expectational stability of rational expectations solutions, depend heavily on the expectational effects of time-varying policy. These findings suggest that uncertainty over future fiscal policy may curb the effectiveness of monetary policy, or otherwise constrain the actions of central bankers. In carrying out this research agenda, my work also examines the relationship between determinacy and expectational stability in a general class of Markov-switching DSGE models.

O presente trabalho teve por objetivo investigar se há evidências de que o regime de política cambial brasileiro teria se alterado no pós-crise econômico-financeira internacional de 2008, além de captar insights acerca da eficácia dos instrumentos de intervenção recentemente aplicados sobre o mercado de moedas e acerca do poder explicativo dos fundamentos da taxa de câmbio. Três fatos estilizados do mercado de câmbio brasileiro incitam essa investigação. O primeiro deles encontra-se no histórico de mudanças de regime cambial do Brasil e das demais economias emergentes, as quais geralmente têm ocorrido em momentos de crises internacionais por impossibilidade dos governos em sustentar o regime vigente. O segundo assenta-se na dinâmica recente do real cuja variação tem se descolado da dinâmica das demais moedas commodities currencies. Por fim, o terceiro ponto está nas inovações recentes em política de intervenção das autoridades monetárias e fiscais visando à gestão da cotação da moeda com medidas tais como as modificações das alíquotas do IOF sobre operações cambiais. Para o alcance dos objetivos foi utilizado o modelo Markov Switching desenvolvido por Hamilton (1989) aplicado ao modelo estrutural de curto prazo para taxa de câmbio, no qual foram consideradas como variáveis explicativas os fundamentos e as intervenções na taxa de câmbio descritas na literatura atual. O modelo foi estimado com ambas as variáveis sujeitas a estados não observáveis, cujas probabilidades de ocorrência são geradas por um processo markoviano. Como resultado foi identificado que não há evidências representativas de modificação na dinâmica da taxa de câmbio no pós-crise que conduzam a interpretação de alteração no regime de política cambial adotado pelo Brasil. Verificou-se também que as intervenções das autoridades monetárias e fiscais não obtiveram eficácia em gerir ou direcionar a variação ou nível da moeda. Ademais, a aplicação do modelo de mudança de regime na série da taxa de câmbio permitiu compreender a sua dinâmica no período recente e o modo como os fundamentos e intervenção perdem e ganham influência na determinação da cotação ao longo dos ciclos da moeda. / This study seeks evidences of changes in the Brazilian foreign exchange rate regime after the international economic and financial crisis of 2008. Furthermore, captures insights on the effectiveness of the intervention measures recently applied on the currency market and the explanatory power of the fundamentals of exchange rates. Three particular facts of the Brazilian foreign exchange market stimulated this research. First, the historical changes of foreign exchange rate regimes in Brazil and other emerging economies. Generally, it has occurred in times of international crises due to the failure of governments to sustain the regime. Second, recent deviation of the Real, which has been detached from the dynamics of other commodities currencies. Finally, the third fact is the recent innovations on monetary and fiscal intervention policies by authorities in order to manage currency value, such as adjustments of IOF on foreign exchange transactions. This investigation uses Markov switching model, developed by Hamilton (1989), applied to the structural model for short-term exchange rate, considering the fundamentals and interventions on the exchange rate described in the current literature as explanatory variables. The model was estimated with both variables subjected to unobservable states, whose probabilities of occurrence are generated by a Markov process. As result, there is no significant evidence of changes in the dynamic of exchange rate in the post-crisis that explains changes in foreign exchange rate regimes adopted by Brazil. The intervention by monetary authorities was not efficient in managing or guiding the dynamic of foreign exchange rate. In addition, the application of the Markov switching model in the foreign exchange rate series allowed understanding the dynamics in recent periods and how fundamentals and interventions loses and gain influence in determining prices throughout the currency cycles.

O presente trabalho teve por objetivo investigar se há evidências de que o regime de política cambial brasileiro teria se alterado no pós-crise econômico-financeira internacional de 2008, além de captar insights acerca da eficácia dos instrumentos de intervenção recentemente aplicados sobre o mercado de moedas e acerca do poder explicativo dos fundamentos da taxa de câmbio. Três fatos estilizados do mercado de câmbio brasileiro incitam essa investigação. O primeiro deles encontra-se no histórico de mudanças de regime cambial do Brasil e das demais economias emergentes, as quais geralmente têm ocorrido em momentos de crises internacionais por impossibilidade dos governos em sustentar o regime vigente. O segundo assenta-se na dinâmica recente do real cuja variação tem se descolado da dinâmica das demais moedas commodities currencies. Por fim, o terceiro ponto está nas inovações recentes em política de intervenção das autoridades monetárias e fiscais visando à gestão da cotação da moeda com medidas tais como as modificações das alíquotas do IOF sobre operações cambiais. Para o alcance dos objetivos foi utilizado o modelo Markov Switching desenvolvido por Hamilton (1989) aplicado ao modelo estrutural de curto prazo para taxa de câmbio, no qual foram consideradas como variáveis explicativas os fundamentos e as intervenções na taxa de câmbio descritas na literatura atual. O modelo foi estimado com ambas as variáveis sujeitas a estados não observáveis, cujas probabilidades de ocorrência são geradas por um processo markoviano. Como resultado foi identificado que não há evidências representativas de modificação na dinâmica da taxa de câmbio no pós-crise que conduzam a interpretação de alteração no regime de política cambial adotado pelo Brasil. Verificou-se também que as intervenções das autoridades monetárias e fiscais não obtiveram eficácia em gerir ou direcionar a variação ou nível da moeda. Ademais, a aplicação do modelo de mudança de regime na série da taxa de câmbio permitiu compreender a sua dinâmica no período recente e o modo como os fundamentos e intervenção perdem e ganham influência na determinação da cotação ao longo dos ciclos da moeda. / This study seeks evidences of changes in the Brazilian foreign exchange rate regime after the international economic and financial crisis of 2008. Furthermore, captures insights on the effectiveness of the intervention measures recently applied on the currency market and the explanatory power of the fundamentals of exchange rates. Three particular facts of the Brazilian foreign exchange market stimulated this research. First, the historical changes of foreign exchange rate regimes in Brazil and other emerging economies. Generally, it has occurred in times of international crises due to the failure of governments to sustain the regime. Second, recent deviation of the Real, which has been detached from the dynamics of other commodities currencies. Finally, the third fact is the recent innovations on monetary and fiscal intervention policies by authorities in order to manage currency value, such as adjustments of IOF on foreign exchange transactions. This investigation uses Markov switching model, developed by Hamilton (1989), applied to the structural model for short-term exchange rate, considering the fundamentals and interventions on the exchange rate described in the current literature as explanatory variables. The model was estimated with both variables subjected to unobservable states, whose probabilities of occurrence are generated by a Markov process. As result, there is no significant evidence of changes in the dynamic of exchange rate in the post-crisis that explains changes in foreign exchange rate regimes adopted by Brazil. The intervention by monetary authorities was not efficient in managing or guiding the dynamic of foreign exchange rate. In addition, the application of the Markov switching model in the foreign exchange rate series allowed understanding the dynamics in recent periods and how fundamentals and interventions loses and gain influence in determining prices throughout the currency cycles.

RESUMO No início de 1995 foi adotado no Brasil o Plano Real, tendo como um dos seus tripés de sustentação a busca pelo combate ao processo inflacionário crônico brasileiro que já se estendia por um longo período. Assim, a política monetária passou a ter um papel importante na determinação das variáveis macroeconômicas. Este trabalho busca analisar uma regra de política monetária que capte as variações ocorridas em todo o período do Plano Real, se estendendo até meados de 2005, bem como se deram as relações entre as variáveis econômicas neste período. A especificação proposta consiste na estimação de modelos não-lineares distintos dependendo do estado da economia (em crise ou fora de crise). Utilizamos um modelo com chaveamento Markoviano para a dinâmica da taxa de juros nominal onde a determinação de períodos de crise é feita por uma variável nãoobservada. Além disso, procuramos adotar dois algoritmos distintos de estimação, Expectation-Maximization (EM) e Monte Carlo Markov Chain (MCMC), concluindo que a análise para ambos é bastante próxima, sendo identificados os mesmos períodos entre regimes. Finalmente, motivamos a estimação através de modelos econômicos teóricos cujas dinâmicas são compatíveis com uma regra de fixação de juros não-linear, avaliando os padrões de resposta a impulso condicionados ao estado da economia (regimes de estabilidade e crise econômica). / ABSTRACT In the beginning of 1995, continuing the process of inflation combat, the monetary policy should have been an important role in the determinacy of macroeconomics variables. This work has a target analyzing a monetary rule that reflects the occurred variations in every Real Plan?s period. The specification proposed by the authors consists in an estimation of two independent nonlinear models for different states of the nature (crises or not crises). Here we estimate a model where the dynamic of the nominal interest rate follows a Markov Switching process and the regimes are unobservable variables. In addition, we try adopting two different algorithms to estimation; Expectation-Maximization (EM) and Monte Carlo Markov Chain (MCMC), concluded that the results are very similar. Finally, we motivate the estimations analyzing models where the theoretical dynamics of the economy are compatible with a nonlinear interest rate rule, analyzing the impulse response conditioned to state of economy (regimes of crises or not crises).

Este trabalho estima, utilizando dados trimestrais de 1999 a 2011, o impacto dinâmico de um estímulo fiscal no Brasil sobre as principais variáveis macroeconômicas Brasileiras. Na estimativa dos impactos permitiu-se que as expectativas dos agentes econômicas fossem afetadas pela existência e probabilidade de alternância de regimes (foram detectados dois regimes) na política monetária do país. Os parâmetros da regra da política monetária, nos dois regimes detectados, foram estimados através de um modelo - composto apenas pela equação da regra da política monetária - que permite uma mudança de regime Markoviana. Os parâmetros do único regime encontrado para a política fiscal foram estimados por um modelo Vetorial de Correção de Erros (Vector Error Correction Model - VEC), composto apenas pelas variáveis pertencentes à regra da política fiscal. Os parâmetros estimados, para os diversos regimes das políticas monetária e fiscal, foram utilizados como auxiliares na calibragem de um modelo de equilíbrio geral estocástico dinâmico (MEGED), com mudanças de regime, com rigidez nominal de preços e concorrência monopolística (como em Davig e Leeper (2011)). Após a calibragem do MEGED os impactos dinâmicos de um estímulo fiscal foram obtidos através de uma rotina numérica (desenvolvida por Davig e Leeper (2006)) que permite obter o equilíbrio dinâmico do modelo resolvendo um sistema de equações de diferenças de primeira ordem expectacionais dinâmicas não lineares. Obtivemos que a política fiscal foi passiva durante todo o período analisado e que a política monetária foi sempre ativa, porém sendo em determinados momentos menos ativa. Em geral, em ambas as combinações de regimes, um choque não antecipado dos gastos do governo leva ao aumento do hiato do produto, aumento dos juros reais, redução do consumo privado e (em contradição com o resultado convencional) redução da taxa de inflação. / This paper estimates, using quarterly data from 1999 to 2011, the dynamic impacts of a fiscal stimulus in Brazil on key Brazilian macroeconomic variables. The estimates take into account the effects of the existence and of the probabilities of occurrence of the switching monetary policy regimes (two regimes were detected) on agents expectations formation. The monetary policy rules parameters, in the two detected regimes, were estimated through a Markov regime-switching model composed only by the monetary policy rule equation. The fiscal rules parameters of the unique detected fiscal policy regime were estimated through a Vector Error Correction (VEC) model composed only by the variables pertained to the fiscal policy rule. The monetary and fiscal policy rules parameters were auxiliary in the calibration of a Dynamic Stochastic General Equilibrium (DSGE) model with regime-switching, nominal price rigidity and monopolistic competition (as in Davig and Leeper (2011)). After the DSGEs calibration the fiscal stimuluss impacts were obtained through a numerical routine (developed by Davig and Leeper (2006)) that solves a set of nonlinear expectational first-order difference equations and gives the dynamic equilibrium of the model. Our results suggest that fiscal policy was passive during the whole period and that monetary policy was always active, but they were more active at certain times and in others, less active. Overall, in both combinations of regimes, a government spending shock induces an increase in the output gap, increases in real interest rates, a reduction in private consumption and (contrary to the conventional wisdom) a reduction in inflation.