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A new approach to integrating expectations into VAR models

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  • Doh, Taeyoung
  • Smith, A. Lee

Abstract

Expectations play a central role in macroeconomics. Expectations are empirically measured from surveys or financial markets and are frequently analyzed in Vector autoregressive (VAR) models alongside realized data of the same variable. However, this leads to two different expectations for the same variable: the VAR-based forecast and the external forecast. This paper proposes a Bayesian prior over the VAR parameters which allows for varying degrees of consistency between these two forecasts. As we demonstrate in two applications, our approach can sharpen structural VAR identification of forward guidance shocks and enhances VAR forecasts of inflation tail risks.

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  • Doh, Taeyoung & Smith, A. Lee, 2022. "A new approach to integrating expectations into VAR models," Journal of Monetary Economics, Elsevier, vol. 132(C), pages 24-43.
    • Handle: RePEc:eee:moneco:v:132:y:2022:i:c:p:24-43
    DOI: 10.1016/j.jmoneco.2022.08.001
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    Cited by:

    1. Todd E. Clark & Gergely Ganics & Elmar Mertens, 2022. "Constructing Fan Charts from the Ragged Edge of SPF Forecasts," Working Papers 22-36, Federal Reserve Bank of Cleveland.

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    More about this item

    Keywords

    Bayesian vector autoregression (VAR); Sign restrictions; Information rigidities; Monetary policy; Forward guidance; Inflation expectations;
    All these keywords.

    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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