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Forward-Looking Information in VAR Models and the Price Puzzle

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  • Sophocles N. Brissimis

    () (Bank of Greece, Economic Research Department and University of Piraeus)

  • Nicholas S. Magginas

    (Athens University of Economics and Business and National Bank of Greece)

Abstract

In this paper we suggest a VAR specification that proves to be successful in resolving the price puzzle featuring in VARs used for monetary policy analysis. We show that augmenting a standard VAR with a small number of variables that have forward-looking informational content is capable of producing theory-consistent responses to monetary policy shocks. The VAR is estimated for the US with data covering the period 1989-2001, which is characterized by a relatively homogeneous monetary policy regime and a pronounced price puzzle in standard VAR specifications. Most important among these forward-looking variables are the federal funds rate future reflecting expectations of future monetary policy and a leading composite indicator providing information about near-term developments in economic activity. In view of the increasing ability of financial markets to better predict monetary policy movements, financial asset prices, such as the federal funds rate futures, are ideal candidates for incorporating parsimoniously a large amount of information into a lowdimension VAR.

Suggested Citation

  • Sophocles N. Brissimis & Nicholas S. Magginas, 2004. "Forward-Looking Information in VAR Models and the Price Puzzle," Working Papers 10, Bank of Greece.
  • Handle: RePEc:bog:wpaper:10
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    More about this item

    Keywords

    Monetary transmission mechanism; VAR models; Fed funds futures; price puzzle;

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • G1 - Financial Economics - - General Financial Markets

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