Working Paper: NBER ID: w10220
Authors: Ben S. Bernanke; Jean Boivin; Piotr Eliasz
Abstract: Structural vector autoregressions (VARs) are widely used to trace out the effect of monetary policy innovations on the economy. However, the sparse information sets typically used in these empirical models lead to at least two potential problems with the results. First, to the extent that central banks and the private sector have information not reflected in the VAR, the measurement of policy innovations is likely to be contaminated. A second problem is that impulse responses can be observed only for the included variables, which generally constitute only a small subset of the variables that the researcher and policymaker care about. In this paper we investigate one potential solution to this limited information problem, which combines the standard structural VAR analysis with recent developments in factor analysis for large data sets. We find that the information that our factor-augmented VAR (FAVAR) methodology exploits is indeed important to properly identify the monetary transmission mechanism. Overall, our results provide a comprehensive and coherent picture of the effect of monetary policy on the economy.
Keywords: monetary policy; FAVAR; vector autoregression; economic variables
JEL Codes: E3; E4; E5; C3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Monetary policy shocks (E39) | Better identification of monetary transmission mechanism (E50) |
| Broader range of data (C80) | Better identification of monetary transmission mechanism (E50) |
| FAVAR methodology (C59) | More accurate impulse response functions (C22) |
| FAVAR approach (C59) | Understanding effects of monetary policy (E52) |
| FAVAR approach (C59) | Plausible estimates of responses of economic variables (C51) |
| FAVAR model (C22) | Consistent measure of the effect of monetary policy (C54) |
| Contractionary monetary policy shocks (E49) | Declines in real activity (E39) |
| Contractionary monetary policy shocks (E49) | Declines in prices (E30) |