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An alternative explanation of the price puzzle

  • Giordani, Paolo

    ()

    (Dept. of Economics, Stockholm School of Economics)

This paper proposes a simple explanation for the frequent appearance of a price puzzle in VARs designed for monetary policy analysis. It suggests that the best method of solving the puzzle implies a close connection between theory and empirics rather than the introduction of a commodity price. It proves that the omission of a measure of output gap (or potential output) spuriously produces a price puzzle (and several other incorrect conclusions) in a wide class of commonly used models. This can happen even if the model admits a triangular identification and if the forecasts produced by the misspecified VAR are optimal. When the model is tested on US data, all predictions are supported.

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File URL: http://swopec.hhs.se/hastef/papers/hastef0414.pdf
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Paper provided by Stockholm School of Economics in its series SSE/EFI Working Paper Series in Economics and Finance with number 414.

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Length: 37 pages
Date of creation: 04 Dec 2000
Date of revision: 06 Dec 2000
Handle: RePEc:hhs:hastef:0414
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The Economic Research Institute, Stockholm School of Economics, P.O. Box 6501, 113 83 Stockholm, Sweden

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Web page: http://www.hhs.se/
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  19. Svensson, Lars, 2000. "The Zero Bound in an Open Economy: A Foolproof Way of Escaping from a Liquidity Trap," Seminar Papers 687, Stockholm University, Institute for International Economic Studies.
  20. Joutz, Fred & Stekler, H. O., 2000. "An evaluation of the predictions of the Federal Reserve," International Journal of Forecasting, Elsevier, vol. 16(1), pages 17-38.
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  25. Scott, Alasdair, 2003. "APPLIED MACROECONOMETRICS Carlo A. Favero Oxford University Press, 2001," Macroeconomic Dynamics, Cambridge University Press, vol. 7(02), pages 313-315, April.
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