Working Paper: CEPR ID: DP1743
Authors: Fabio C. Bagliano; Carlo A. Favero
Abstract: This paper evaluates VAR models designed to analyse the monetary policy transmission mechanism in the United States by considering three issues: specification, identification, and the effect of the omission of the long-term interest rate. Specification analysis suggests that only VAR models estimated on a single monetary regime feature parameter stability and do not show signs of mis-specification. The identification analysis shows that VAR-based monetary policy shocks and policy disturbances identified from alternative sources are not highly correlated but yield similar descriptions of the monetary transmission mechanism. Lastly, the inclusion of the long-term interest rate in a benchmark VAR delivers a more precise estimation of the structural parameters capturing behaviour in the market for reserves and shows that contemporaneous fluctuations in long-term interest rates are an important determinant of the monetary authority?s reaction function.
Keywords: monetary transmission; VAR models
JEL Codes: E44; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| stability of the model (C62) | monetary regime (E42) |
| VAR-based monetary policy shocks (E39) | monetary transmission mechanism (E52) |
| alternative measures of monetary policy (E52) | monetary transmission mechanism (E52) |
| long-term interest rate (E43) | structural parameter estimates (C51) |
| fluctuations in long-term interest rates (E43) | monetary authority's reaction function (E52) |
| long-term interest rates (E43) | short-term policy rate (E43) |