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An alternative explanation of the price puzzle

  • Giordani, Paolo

This paper proposes a simple explanation for the frequent appearance of a price puzzle in VARs designed for monetary policy analysis. It suggests that the best method of solving the puzzle implies a close connection between theory and empirics rather than the introduction of a commodity price. It proves that the omission of a measure of output gap (or potential output) spuriously produces a price puzzle (and several other incorrect conclusions) in a wide class of commonly used models. This can happen even if the model admits a triangular identification and if the forecasts produced by the misspecified VAR are optimal. When the model is tested on US data, all predictions are supported.

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Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 51 (2004)
Issue (Month): 6 (September)
Pages: 1271-1296

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Handle: RePEc:eee:moneco:v:51:y:2004:i:6:p:1271-1296
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