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Reduced-Rank Identification of Structural Shocks in VARs

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Author Info
Yuriy Gorodnichenko (University of Michigan)

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Abstract

This paper integrates imposing a factor structure on residuals in vector autoregressions (VARs) into structural VAR analysis. Identification, estimation and testing procedures are discussed. The paper applies this approach to the well-known problem of studying the effects of monetary policy in open economy VAR models. The use of factor structure in identifying structural shocks is shown to resolve three long-standing puzzles in VAR literature. First, the price level does not increase in response to a monetary tightening. Second, the exchange rate appreciates on impact and then gradually depreciates. Hence, no price level and exchange rate puzzles are found. Third, monetary policy shocks are much less volatile than suggested by standard VAR identification schemes. In addition, the paper suggests that the apparent weak contemporaneous cross-variable responses and strong own responses in structural VARs can be an artifact of identifying assumptions and vanish after imposing a factor structure on the shocks.

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Paper provided by EconWPA in its series Macroeconomics with number 0512011.

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Length: 36 pages
Date of creation: 15 Dec 2005
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Handle: RePEc:wpa:wuwpma:0512011

Note: Type of Document - pdf; pages: 36
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Related research
Keywords: Vector autoregressions; identification; factor structure; monetary policy;

Find related papers by JEL classification:
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions

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