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Modest Macroeconomic Effects of Monetary Policy Shocks during the Great Moderation: An Alternative Interpretation

Listed author(s):
  • Efrem Castelnuovo

    ()

    (Melbourne Institute of Applied Economic and Social Research, The University of Melbourne; Department of Economics, The University of Melbourne; and Department of Economics and Management, University of Padova)

Cholesky-VAR impulse responses estimated with post-1984 U.S. data predict modest macroeconomic reactions to monetary policy shocks. We interpret this evidence by employing an estimated medium-scale DSGE model of the business cycle as a DataGenerating Process in a Monte Carlo exercise in which a Cholesky-VAR econometrician is asked to estimate the effects of an unexpected, temporary increase in the policy rate. Our structural DSGE model predicts conventional macroeconomic reactions to a policy shock. In contrast, our Monte Carlo VAR results replicate our evidence obtained with actual U.S. data. Hence, modest macroeconomic effects may very well be an artifact of Cholesky-VARs. A combination of supply and demand shocks may be behind the inability of Cholesky-VARs to replicate the actual macroeconomic responses. The difference in the VAR responses obtained with Great Inflation vs. Great Moderation data may be due to instabilities in the parameters related to households’ and firms’ programs, more than to a more aggressive systematic monetary policy. A Monte Carlo assessment of sign restrictions as an alternative identification strategy is also proposed.

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Paper provided by Melbourne Institute of Applied Economic and Social Research, The University of Melbourne in its series Melbourne Institute Working Paper Series with number wp2016n30.

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Length: 35pp
Date of creation: Oct 2016
Handle: RePEc:iae:iaewps:wp2016n30
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