The Econometrics of Monetary Policy: An Overview

This chapter concentrates on the econometrics of monetary policy. We describe the evolution of models estimated to evaluate the macroeconomic impact of monetary policy. We argue that the main challenge for the econometrics of monetary policy is in combining theoretical models and information from the data to construct empirical models. The failure of the large econometric models at the beginning of the 1970s might be explained by their incapability of taking proper account of both these aspects. The critiques by Lucas and Sims have generated an alternative approach which, at least initially, has been almost entirely dominated by theory. The LSE approach has instead concentrated on the properties of the statistical models and on the best way of incorporating information from the data into the empirical models, paying little attention to the economic foundation of the adopted specification. The realization that the solution of a DSGE model can be approximated by a restricted VAR, which is also a statistical model, has generated a potential link between the two approaches. The open question is which type of VARs are most appropriate for the econometric analysis of monetary policy.