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The price puzzle: Mixing the temporary and permanent monetary policy shocks

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Abstract

We argue that the correct identification of monetary policy shocks in a vector autoregression requires that the identification scheme distinguishes between permanent and transitorymonetary policy shocks. The permanent shocks reflect changes in the inflation target while the transitory shocks represent temporary deviations from the interest rate reaction function. Whereas both shocks may raise the nominal interest rate on impact, the inflation and output responses of the two shocks are different. We show, using a simple simulation experiment, that a failure to distinguish between the two types of shocks can result in a ”price puzzle”.

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File URL: http://www.norges-bank.no/en/Published/Papers/Working-Papers/2008/WP-200818/
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Bibliographic Info

Paper provided by Norges Bank in its series Working Paper with number 2008/18.

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Length: 12 pages
Date of creation: 03 Nov 2008
Date of revision:
Handle: RePEc:bno:worpap:2008_18

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Keywords: Monetary policy shocks; VAR modeling; identification; price puzzle;

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Cited by:
  1. Rosmy Jean Louis & Mohamed Osman & Faruk Balli, 2010. "Is the US Dollar a Suitable Anchor for the Newly Proposed GCC Currency?," The World Economy, Wiley Blackwell, vol. 33(12), pages 1898-1922, December.
  2. Jean Louis, Rosmy & Brown, Ryan & Balli, Faruk, 2011. "On the Feasibility of Monetary Union: Does It Make Sense to Look for Shocks Symmetry across Countries When None of the Countries Constitutes an Optimum Currency Area?," MPRA Paper 39942, University Library of Munich, Germany.

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