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Assessing the transmission of monetary policy using dynamic factor models

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  • Korobilis, Dimitris

Abstract

This paper extends the current literature which questions the stability of the monetary transmission mechanism, by proposing a factor-augmented vector autoregressive (VAR) model with time-varying coefficients and stochastic volatility. The VAR coefficients and error covariances may change gradually in every period or be subject to abrupt breaks. The model is applied to 143 post-World War II quarterly variables fully describing the US economy. I show that both endogenous and exogenous shocks to the US economy resulted in the high inflation volatility during the 1970s and early 1980s. The time-varying factor augmented VAR produces impulse responses of inflation which significantly reduce the price puzzle. Impulse responses of other indicators of the economy show that the most notable changes in the transmission of unanticipated monetary policy shocks occurred for GDP, investment, exchange rates and money.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 27593.

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Date of creation: May 2009
Date of revision: Nov 2010
Handle: RePEc:pra:mprapa:27593

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Related research

Keywords: Structural FAVAR; time varying parameter model; monetary policy;

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References

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  1. Uhlig, Harald, 1999. "What are the Effects of Monetary Policy on Output? Results from an Agnostic Identification Procedure," CEPR Discussion Papers 2137, C.E.P.R. Discussion Papers.
  2. Domenico Giannone & Michele Lenza & Lucrezia Reichlin, 2008. "Explaining The Great Moderation: It Is Not The Shocks," Journal of the European Economic Association, MIT Press, vol. 6(2-3), pages 621-633, 04-05.
  3. Giannone, Domenico & Reichlin, Lucrezia & Small, David, 2008. "Nowcasting: The real-time informational content of macroeconomic data," Journal of Monetary Economics, Elsevier, vol. 55(4), pages 665-676, May.
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  14. Koop, Gary & Korobilis, Dimitris, 2009. "Bayesian Multivariate Time Series Methods for Empirical Macroeconomics," MPRA Paper 20125, University Library of Munich, Germany.
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  16. Boivin, J. & Giannoni, M., 2007. "DSGE Models in a Data-Rich Environment," Working papers 162, Banque de France.
  17. Castelnuovo, Efrem & Surico, Paolo, 2009. "Monetary policy, inflation expectations and the price puzzle," Research Discussion Papers 30/2009, Bank of Finland.
  18. Thomas Doan & Robert B. Litterman & Christopher A. Sims, 1983. "Forecasting and Conditional Projection Using Realistic Prior Distributions," NBER Working Papers 1202, National Bureau of Economic Research, Inc.
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Cited by:
  1. Christiane Baumeister & Philip Liu & Haroon Mumtaz, 2012. "Changes in the Effects of Monetary Policy on Disaggregate Price Dynamics," Working Papers 12-13, Bank of Canada.
  2. Andrew Stuart Duncan & Alain Kabundi, 2011. "Global Financial Crises and Time-varying Volatility Comovement in World Equity Markets," Working Papers 253, Economic Research Southern Africa.

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