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The Monetary Transmission Mechanism and Inflation Targeting: A Regime-Switching VAR Approach for Canada

Author

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  • Ronald H. Lange

Abstract

This study employs a Markov-switching VAR with regime-dependent dynamics to assess the transmission mechanism of monetary policy in Canada. The regime-switching estimations divide the sam?ple period stochastically into two continuous regimes that corresponds to the periods before and after explicit-inflation targeting in Canada. The empirical results indicate relatively large differences in both the innovation process due to the variance component of the VAR and the propagation mech?anism due to the regime-dependent systematic component. The pre-targeting regime corresponds to much larger innovations in the macroeconomic variables and overall larger systematic responses of the macroeconomic variables to the innovation processes, suggesting a stronger monetary transmission mechanism in the regime. However, variance decompositions and counterfactual analysis sug?gest that monetary policy has become more responsive to fluctuations in output growth and inflation in the target regime. Overall, about 80 per cent of the variations in the monetary policy rate in the current regime can be explained by the systematic reactions of policy to output growth and inflation at the relevant policy horizons.

Suggested Citation

  • Ronald H. Lange, 2016. "The Monetary Transmission Mechanism and Inflation Targeting: A Regime-Switching VAR Approach for Canada," Applied Economics and Finance, Redfame publishing, vol. 3(2), pages 263-279, May.
    • Handle: RePEc:rfa:aefjnl:v:3:y:2016:i:2:p:263-279
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    Citations

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    Cited by:

    1. Su, Hui & Zhou, Na & Wu, Qiaosheng & Bi, Zhiwei & Wang, Yuli, 2023. "Investigating price fluctuations in copper futures: Based on EEMD and Markov-switching VAR model," Resources Policy, Elsevier, vol. 82(C).
    2. Chen, Jinyu & Zhu, Xuehong & Zhong, Meirui, 2019. "Nonlinear effects of financial factors on fluctuations in nonferrous metals prices: A Markov-switching VAR analysis," Resources Policy, Elsevier, vol. 61(C), pages 489-500.
    3. Ronald Henry Lange, 2017. "Macroeconomic Switching Regimes and Monetary Policy in Canada," Applied Economics and Finance, Redfame publishing, vol. 4(4), pages 17-31, July.

    More about this item

    Keywords

    monetary transmission mechanism; regime switching; vector autoregessions;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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