Monetary policy shocks and financial conditions: A Monte Carlo experiment |
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| Institution: | 1. Department of Economics — FEA-RP USP, Brazil;2. Department of Economics — UFRGS, Brazil;1. Department of Statistical Science, Duke University, USA;2. Faculty of Economics, The University of Tokyo, Japan;3. Insper Institute of Education and Research, Brazil;4. Nippon Life Insurance Company, Japan;1. Federal Reserve Bank of San Francisco, USA;2. Department of Economics, University of California, Davis, USA;3. Department of Economics, University of Bonn, Germany;4. Centre for Economic Policy Research, UK;5. Graduate School of Management, University of California, Davis, USA;6. National Bureau of Economic Research, USA |
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| Abstract: | The effects of monetary policy shocks on financial conditions are often estimated by appealing to recursive Vector AutoRegressions (VARs). We assess the ability of this class of VARs to recover the true effects of a monetary policy shock via a Monte Carlo experiment in which the Data Generating Process is a Dynamic Stochastic General Equilibrium (DSGE) model featuring macro-finance interactions and estimated with U.S. quarterly data. Our DSGE model predicts a negative and significant reaction of financial conditions to an unexpected monetary policy tightening. We point out that such reaction is just overlooked by recursive VARs. Moreover, we show that Cholesky-VARs may substantially underestimate the welfare costs due to macroeconomic fluctuations. |
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