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Are policy counterfactuals based on structural VAR's reliable?

  • Benati, Luca

Based on standard New Keynesian models I show that policy counterfactuals based on the theoretical structural VAR representations of the models fail to reliably capture the impact of changes in the parameters of the Taylor rule on the (reduced-form) properties of the economy. Based on estimated models for the Great Inflation and the most recent period, I show that, as a practical matter, the problem appears to be non-negligible. These results imply that the outcomes of SVAR-based policy counterfactuals should be regarded with caution, as their informativeness for the specific issue at hand–e.g., understanding the role played by monetary policy in exacerbating the Great Depression, causing the Great Inflation, or fostering the Great Moderation–is, in principle, open to question. Finally, I argue that SVAR-based policy counterfactuals suffer from a crucial logical shortcoming: given that their reliability crucially depends on unknown structural characteristics of the underlying data generation process, such reliability cannot simply be assumed, and can instead only be ascertained with a reasonable degree of confidence by estimating structural (DSGE) models. JEL Classification: E30, E32

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Paper provided by European Central Bank in its series Working Paper Series with number 1188.

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Date of creation: May 2010
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Handle: RePEc:ecb:ecbwps:20101188
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  1. Guido Ascari, 2004. "Staggered prices and trend inflation: some nuisances," Macroeconomics 0404029, EconWPA.
  2. Benati, Luca & Surico, Paolo, 2008. "VAR analysis and the Great Moderation," Working Paper Series 0866, European Central Bank.
  3. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, vol. 48(1), pages 1-48, January.
  4. Andrés, Javier & López-Salido, J David & Nelson, Edward, 2008. "Money and the Natural Rate of Interest: Structural Estimates for the United States and the Euro Area," CEPR Discussion Papers 6812, C.E.P.R. Discussion Papers.
  5. Athanasios Orphanides, 2004. "Monetary policy in deflation: the liquidity trap in history and practice," Finance and Economics Discussion Series 2004-01, Board of Governors of the Federal Reserve System (U.S.).
  6. Giorgio E. Primiceri, 2005. "Time Varying Structural Vector Autoregressions and Monetary Policy," Review of Economic Studies, Oxford University Press, vol. 72(3), pages 821-852.
  7. Benati, Luca & Goodhart, Charles, 2010. "Monetary Policy Regimes and Economic Performance: The Historical Record, 1979-2008," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 21, pages 1159-1236 Elsevier.
  8. Thomas A. Lubik & Frank Schorfheide, 2004. "Testing for Indeterminacy: An Application to U.S. Monetary Policy," American Economic Review, American Economic Association, vol. 94(1), pages 190-217, March.
  9. Sungbae An & Frank Schorfheide, 2007. "Bayesian Analysis of DSGE Models," Econometric Reviews, Taylor & Francis Journals, vol. 26(2-4), pages 113-172.
  10. Fabio Canova & Luca Gambetti, 2003. "Structural changes in the US economy: is there a role for monetary policy?," Economics Working Papers 918, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 2008.
  11. Lubik, Thomas A. & Schorfheide, Frank, 2003. "Computing sunspot equilibria in linear rational expectations models," Journal of Economic Dynamics and Control, Elsevier, vol. 28(2), pages 273-285, November.
  12. Christopher A. Sims & Tao Zha, 2005. "Were There Regime Switches in U.S. Monetary Policy?," Working Papers 92, Princeton University, Department of Economics, Center for Economic Policy Studies..
  13. Richard Clarida & Jordi Gali & Mark Gertler, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," NBER Working Papers 6442, National Bureau of Economic Research, Inc.
  14. Canova, Fabio & Gambetti, Luca & Pappa, Evi, 2006. "The Structural Dynamics of US Output and Inflation: What Explains the Changes?," CEPR Discussion Papers 5879, C.E.P.R. Discussion Papers.
  15. Benati, Luca, 2008. "Investigating inflation persistence across monetary regimes," Working Paper Series 0851, European Central Bank.
  16. Michael Kiley, 2004. "Is Moderate-To-High Inflation Inherently Unstable?," Econometric Society 2004 North American Summer Meetings 193, Econometric Society.
  17. Benati, Luca, 2009. "Would the Bundesbank have prevented the Great Inflation in the United States?," Working Paper Series 1134, European Central Bank.
  18. Christopher A. Sims, 1998. "Role of interest rate policy in the generation and propagation of business cycles: what has changed since the '30s?," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, vol. 42(Jun), pages 121-175.
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