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Dealing with forward-looking expectations and policy rules in quantifying the channels of transmission of monetary policy

Author

Listed:
  • Filippo Altissimo

    () (Bank of Italy, Economic Research Department)

  • Alberto Locarno

    () (Bank of Italy, Economic Research Department)

  • Stefano Siviero

    () (Bank of Italy, Economic Research Department)

Abstract

The issue of appraising the transmission process through which monetary policy affects the economy is receiving wider and increasing attention. In Europe, much of the interest in the effects of monetary policy is arguably a reflection of the introduction of the single currency: to the extent that transmission mechanism differ significantly across euro area countries, heterogenous responses of economic activity and prices to the policy instrument should be expected, an occurrence whose policy implications are of major relevance. To gain some insight into the likely causes of those differences recent studies have attempted to identify and assess separately the channels of transmission of monetary policy. This paper proposes a simple methodology to quantify separately the different parts of the overall impulse response that are transmitted through the various mechanisms at play in a model of the economy. It is shown that, under the maintained assumption of linearity, the decomposition of the effects of monetary policy into a number of channels delivered by our approach is exact (i.e., it leaves no unexplained residual). This conclusion holds regardless of the nature of the expectation formation mechanism and the way in which policy decisions are modelled. The features of the proposed approach are illustrated with an empirical application, using a model that features two distinct transmission channels and assumes rational expectations and a monetary policy reaction rule. We show that our approach produces an exact decomposition of the effects of a monetary policy shock. Moreover, and perhaps more interestingly, our approach gives a deeper insight than do standard impulse responses into the specific features of the model that are most relevant in shaping its observed reaction to the shock.

Suggested Citation

  • Filippo Altissimo & Alberto Locarno & Stefano Siviero, 2002. "Dealing with forward-looking expectations and policy rules in quantifying the channels of transmission of monetary policy," Temi di discussione (Economic working papers) 460, Bank of Italy, Economic Research and International Relations Area.
  • Handle: RePEc:bdi:wptemi:td_460_02
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    References listed on IDEAS

    as
    1. Gourieroux,Christian & Monfort,Alain, 1997. "Time Series and Dynamic Models," Cambridge Books, Cambridge University Press, number 9780521423083, April.
    2. Filippo Altissimo & Antonio Bassanetti & Riccardo Cristadoro & Mario Forni & Marco Lippi & Lucrezia Reichlin & Giovanni Veronese, 2001. "A real time coincident indicator of the euro area business cycle," Temi di discussione (Economic working papers) 436, Bank of Italy, Economic Research and International Relations Area.
    3. S. Sgherri, 1999. "Monetary transmission channels, monetary regimes and consumption behaviour," WO Research Memoranda (discontinued) 602, Netherlands Central Bank, Research Department.
    4. Wallis, Kenneth F, 1980. "Econometric Implications of the Rational Expectations Hypothesis," Econometrica, Econometric Society, vol. 48(1), pages 49-73, January.
    5. Peter van Els & Alberto Locarno & Julian Morgan & Jean-Pierre Villetelle, 2001. "Monetary policy transmission in the euro area: what do aggregate and national structural models tell us?," Temi di discussione (Economic working papers) 433, Bank of Italy, Economic Research and International Relations Area.
    6. Altissimo, Filippo & Bassanetti, Antonio & Cristadoro, Riccardo & Forni, Mario & Hallin, Marc & Lippi, Marco & Reichlin, Lucrezia & Veronese, Giovanni, 2001. "EuroCOIN: A Real Time Coincident Indicator of the Euro Area Business Cycle," CEPR Discussion Papers 3108, C.E.P.R. Discussion Papers.
    7. Fisher, Paul & Salmon, Mark, 1986. "On Evaluating the Importance of Nonlinearity in Large Macroeconometric Models," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 27(3), pages 625-646, October.
    8. Eileen Mauskopf & Jeffrey C. Fuhrer & Peter A. Tinsley, 1990. "The transmission channels of monetary policy: how have they changed?," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Dec, pages 985-1008.
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    Citations

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    Cited by:

    1. Peter van Els & Alberto Locarno & Julian Morgan & Jean-Pierre Villetelle, 2001. "Monetary policy transmission in the euro area: what do aggregate and national structural models tell us?," Temi di discussione (Economic working papers) 433, Bank of Italy, Economic Research and International Relations Area.
    2. Leonardo Gambacorta & Paolo Emilio Mistrulli, 2003. "Bank Capital and Lending Behaviour: Empirical Evidence for Italy," Temi di discussione (Economic working papers) 486, Bank of Italy, Economic Research and International Relations Area.
    3. McAdam, Peter & Morgan, Julian, 2001. "The monetary transmission mechanism at the euro-area level: issues and results using structural macroeconomic models," Working Paper Series 0093, European Central Bank.
    4. Minella, André & Souza-Sobrinho, Nelson F., 2013. "Monetary policy channels in Brazil through the lens of a semi-structural model," Economic Modelling, Elsevier, vol. 30(C), pages 405-419.

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