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A Factor-Augmented Vector Autoregressive Approach to Analyze the Transmission of Monetary Policy

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  • Zulfiqar Ali Wagan
  • Zhang Chen
  • Hakimzadi Wagan

Abstract

Using the factor-augmented vector autoregressive (FAVAR) model proposed by Bernanke et al. (2005), this study explores the effect of monetary policy on a wide range of macroeconomic and financial variables for the US, Canada and the UK. The study makes use of financial data from 1990 to 2016, comprising 55-70 variables of the three major nations to show (1) that factors come with additional informational capability, which summarizes the performance of key macroeconomic variables and (2) the manner in which these variables are affected by contractionary monetary policies. Our findings confirm that monetary policy tightening results in decrease in industrial production, employment, share prices, housing starts and inflation; however, it leads to increase in the three-month treasury bill rate, long-term interest rates and unemployment. Overall, the impact of standardized monetary tightening is similar across the countries studied. These results from the major economies and the inclusion of larger data sets containing more variables would be relevant for policy theorists and practitioners from other countries.

Suggested Citation

  • Zulfiqar Ali Wagan & Zhang Chen & Hakimzadi Wagan, 2019. "A Factor-Augmented Vector Autoregressive Approach to Analyze the Transmission of Monetary Policy," Prague Economic Papers, Prague University of Economics and Business, vol. 2019(6), pages 709-728.
    • Handle: RePEc:prg:jnlpep:v:2019:y:2019:i:6:id:699:p:709-728
    DOI: 10.18267/j.pep.699
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    More about this item

    Keywords

    monetary policy; FAVAR; VAR; Bayesian methods;
    All these keywords.

    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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