Time Consistent Policy in Markov Switching Models.” Working paper 298

In this paper we consider the optimal control problem of models with Markov regime shifts and forward looking agents. These models are general and flexible tools for modelling model uncertainty. An algorithm is devised to compute the solution of a rational expectations model with random parameters or regime shifts. A second algorithm computes the time consistent policy and the resulting Nash Stackelberg equilibrium. The latter algorithm can also handle the case in which the policymaker and the private sector hold different beliefs. We apply these methods to compute the optimal (nonlinear) monetary policy in a small open economy subject to random structural breaks.