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Principal components at work: the empirical analysis of monetary policy with large data sets

  • Massimiliano Marcellino

    (IEP, Bocconi University, IGIER and CEPR, Italy)

  • Carlo A. Favero

    (IEP, Bocconi University, IGIER and CEPR, Italy)

  • Francesca Neglia

    (IGIER-Universit� Bocconi, Italy)

The empirical analysis of monetary policy requires the construction of instruments for future expected inflation. Dynamic factor models have been applied rather successfully to inflation forecasting. In fact, two competing methods have recently been developed to estimate large-scale dynamic factor models based, respectively, on static and dynamic principal components. This paper combines the econometric literature on dynamic principal components and the empirical analysis of monetary policy. We assess the two competing methods for extracting factors on the basis of their success in instrumenting future expected inflation in the empirical analysis of monetary policy. We use two large data sets of macroeconomic variables for the USA and for the Euro area. Our results show that estimated factors do provide a useful parsimonious summary of the information used in designing monetary policy. Copyright © 2005 John Wiley & Sons, Ltd.

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Article provided by John Wiley & Sons, Ltd. in its journal Journal of Applied Econometrics.

Volume (Year): 20 (2005)
Issue (Month): 5 ()
Pages: 603-620

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Handle: RePEc:jae:japmet:v:20:y:2005:i:5:p:603-620
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  2. Mario Forno & Marco Lippi & Lucrezia Reichlin & Filippo Altissimo & Antonio Bassanetti, 2003. "Eurocoin: A Real Time Coincident Indicator Of The Euro Area Business Cycle," Computing in Economics and Finance 2003 242, Society for Computational Economics.
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  10. Christiano, Lawrence J. & Eichenbaum, Martin & Evans, Charles L., 1999. "Monetary policy shocks: What have we learned and to what end?," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 2, pages 65-148 Elsevier.
  11. Mario Forni & Marc Hallin & Lucrezia Reichlin & Marco Lippi, 2000. "The generalised dynamic factor model: identification and estimation," ULB Institutional Repository 2013/10143, ULB -- Universite Libre de Bruxelles.
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  17. Jon Faust, 1998. "The robustness of identified VAR conclusions about money," International Finance Discussion Papers 610, Board of Governors of the Federal Reserve System (U.S.).
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