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Under the same (Chole)sky: DNK models, timing restrictions and recursive identification of monetary policy shocks

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  • Giovanni Angelini
  • Marco M. Sorge

Abstract

Recent structural VAR studies of the monetary transmission mechanism have voiced concerns about the use of recursive identification schemes based on short-run exclusion restrictions. We trace out the effects on impulse propagation of informational constraints embodying classical Cholesky-timing restrictions in otherwise standard Dynamic New Keynesian (DNK) models. By reinforcing internal propagation mechanisms and enlarging a model's equilibrium state space, timing restrictions may produce a non-trivial moving average component of the equilibrium representation, making finite order VARs a poor approximation of true adjustment paths to monetary impulses, albeit correctly identified. They can even serve as an independent source of model-based nonfundamentalness, thereby hampering shock identification via VAR methods. This notwithstanding, restricted DNK models are shown to feature (i) invertible equilibrium representations for the observables and (ii) fast-converging VAR coefficient matrices under empirically tenable parameterizations. This alleviates concerns about identification and lag truncation bias: low-order Cholesky-VARs do well at uncovering the transmission of monetary impulses in a truly Cholesky world.

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  • Giovanni Angelini & Marco M. Sorge, 2021. "Under the same (Chole)sky: DNK models, timing restrictions and recursive identification of monetary policy shocks," Working Papers wp1160, Dipartimento Scienze Economiche, Universita' di Bologna.
  • Handle: RePEc:bol:bodewp:wp1160
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    • C3 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables
    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles

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