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Measuring Monetary Policy In The Uk: A Factor-Augmented Vector Autoregression Model Approach

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  • GIANLUCA LAGANA
  • ANDREW MOUNTFORD

Abstract

This paper investigates the determinants of UK interest rates using a factor-augmented vector autoregression model (VAR), similar to the one suggested by Bernanke, Boivin and Eliasz (Quarterly Journal of Economics, Vol. 120 (2005), No. 1, pp. 387-422). The method allows impulse response functions to be generated for all the variables in the data set and so is able to provide a more complete description of UK monetary policy than is possible using standard VARs. The results show that the addition of factors to a benchmark VAR generates a more reasonable characterization of the effects of unexpected increases in the interest rate and, in particular, gets rid of a 'price puzzle' response present in the benchmark VAR. The extra information generated by this method, however, also brings to light other identification issues, notably house price and stock market 'puzzles'. Importantly the out-of-sample prediction performance of the factor-augmented VARs is also very good and strongly superior to those of the benchmark VAR and simple autoregression models. Copyright Blackwell Publishing Ltd and The University of Manchester, 2005.

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Bibliographic Info

Article provided by University of Manchester in its journal The Manchester School.

Volume (Year): 73 (2005)
Issue (Month): s1 (09)
Pages: 77-98

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Handle: RePEc:bla:manchs:v:73:y:2005:i:s1:p:77-98

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Cited by:
  1. Gianluca Lagana & Pasquale Sgro, 2011. "Fiscal Policy and US-Canadian Trade," Economics Bulletin, AccessEcon, vol. 31(2), pages 1856-1868.
  2. Dees, S. & di Mauro, F. & Pesaran, M.H. & Smith, L.V., 2005. "Exploring the International Linkages of the Euro Area: a Global VAR Analysis," Cambridge Working Papers in Economics 0518, Faculty of Economics, University of Cambridge.
  3. Melina, Giovanni & Villa, Stefania, 2012. "Fiscal policy and lending relationships," Open Access publications from Katholieke Universiteit Leuven urn:hdl:123456789/348272, Katholieke Universiteit Leuven.
  4. Tomas Havranek & Marek Rusnak, 2012. "Transmission Lags of Monetary Policy: A Meta-Analysis," William Davidson Institute Working Papers Series wp1038, William Davidson Institute at the University of Michigan.
  5. Rita Soares, 2011. "Assessing monetary policy in the euro area: a factor-augmented VAR approach," Working Papers w201111, Banco de Portugal, Economics and Research Department.
  6. Ron Smith & Gylfi Zoega, 2005. "Unemployment, Investment and Global Expected Returns: A Panel FAVAR Approach," Birkbeck Working Papers in Economics and Finance 0524, Birkbeck, Department of Economics, Mathematics & Statistics.
  7. Andrés Felipe Londoño & Jorge Andrés Tamayo & Carlos Alberto Velásquez, 2012. "Dinámica de la política monetaria e inflación objetivo en Colombia: una aproximación FAVAR," ENSAYOS SOBRE POLÍTICA ECONÓMICA, BANCO DE LA REPÚBLICA - ESPE.
  8. M. Hashem Pesaran & Ron Smith, 2006. "Macroeconometric Modelling With A Global Perspective," Manchester School, University of Manchester, vol. 74(s1), pages 24-49, 09.
  9. Pang, Iris Ai Jao, 2010. "Forecasting Hong Kong economy using factor augmented vector autoregression," MPRA Paper 32495, University Library of Munich, Germany.

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