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Monetary policy shocks and financial conditions: A Monte Carlo experiment

  • Castelnuovo, Efrem

The effects of monetary policy shocks on financial conditions are often estimated by appealing to recursive Vector AutoRegressions (VARs). We assess the ability of this class of VARs to recover the true effects of a monetary policy shock via a Monte Carlo experiment in which the Data Generating Process is a Dynamic Stochastic General Equilibrium (DSGE) model featuring macro-finance interactions and estimated with U.S. quarterly data. Our DSGE model predicts a negative and significant reaction of financial conditions to an unexpected monetary policy tightening. We point out that such reaction is just overlooked by recursive VARs. Moreover, we show that Cholesky-VARs may substantially underestimate the welfare costs due to macroeconomic fluctuations.

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Article provided by Elsevier in its journal Journal of International Money and Finance.

Volume (Year): 32 (2013)
Issue (Month): C ()
Pages: 282-303

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Handle: RePEc:eee:jimfin:v:32:y:2013:i:c:p:282-303
DOI: 10.1016/j.jimonfin.2012.04.011
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/30443

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