Determination of the equilibrium expansion rate of money when money supply is driven by a time-homogeneous Markov modulated jump diffusion process

This paper is aimed at developing a general equilibrium model useful to determine the equilibrium expansion rate of money supply in a small open stochastic economy. The marginal change of money supply incorporates stylized facts in emerging economies reported in empirical literature such as regime switches in volatility and unexpected sudden jumps (interventions). To model these essentials, money supply will be driven by a time-homogeneous Markov modulated jump diffusion process. Under this framework, it is found that the expansion rate of money supply depends on the current exchange rate depreciation, the interest rate, the average size on the jump process, and the regime switching in volatility. The proposed model allows using the Monte Carlo method to simulate the average path of the equilibrium expansion rate of money.