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Vector Autoregression Analysis and the Great Moderation

Author

Listed:
  • Luca Benati

    (Monetary Policy Strategy Division, European Central Bank)

  • Paolo Surico

    (Monetary Policy Committee Unit, Bank of England)

Abstract

Most analyses of the U.S. Great Moderation have been based on VAR methods, and have consistently pointed toward good luck as the main explanation for the greater macroeconomic stability of recent years. Using data generated by a New-Keynesian model in which the only source of change is the move from passive to active monetary policy, we show that VARs may misinterpret good policy for good luck. In particular, we detect signicant breaks in estimated VAR innovation variances, although in the data generating process the volatilities of the structural shocks are constant across policy regimes. Counterfactual simulations, structural and reduced-form, point toward the incorrect conclusion of good luck. Our results cast doubts on the existing notion that VAR evidence is inconsistent with the good policy explanation of the Great Moderation.

Suggested Citation

  • Luca Benati & Paolo Surico, 2007. "Vector Autoregression Analysis and the Great Moderation," Discussion Papers 18, Monetary Policy Committee Unit, Bank of England.
    • Handle: RePEc:mpc:wpaper:0018
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    References listed on IDEAS

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    Cited by:

    1. Francesco Bianchi & Haroon Mumtaz & Paolo Surico, 2009. "Dynamics of the term structure of UK interest rates," Bank of England working papers 363, Bank of England.
    2. Bianchi, Francesco & Mumtaz, Haroon & Surico, Paolo, 2009. "Dynamics of the term structure of UK interest rates," Bank of England working papers 363, Bank of England.
    3. Erdemlioglu, Deniz M & Xiao, Wei, 2008. "Indeterminate Equilibria in New Keynesian DSGE Model: An Application to the US Great Moderation," MPRA Paper 10322, University Library of Munich, Germany.

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    More about this item

    Keywords

    Great inflation; passive policy; break tests; vector autoregressions;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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