Solving the price puzzle with an alternative indicator of monetary policy

We identify the effects of monetary policy shocks on macroeconomic variables in VARs using the Divisia M4 measure of money as the policy indicator variable. We obtain theoretically sensible responses—whether or not a commodity price index is included. Thus, we eliminate the well-known empirical puzzles from the VAR by a novel choice in a policy variable, rather than the usual attachment of an ad hoc variable.     

Estimating the effects of monetary policy shocks: does lag structure matter?

This paper examines the implications of lag structure for estimating the effects of monetary policy shocks in a VAR. A symmetric lag structure in which all variables have the same lag length and an asymmetric lag structure in which the lag length differs across variables but is the same for a particular variable in each equation of the model are examined. This is important in light of the fact that the true lag structure is generally not known. Four commonly used identification schemes are employed to identify monetary policy shocks. Monte Carlo simulations strongly indicate that the lag structure of a VAR model does matter when assessing the quantitative effects of monetary policy shocks. Given the inherent uncertainty about the true lag structure in practice, it is thus important that one compare the impulse response functions from both symmetric lag and asymmetric lag VARs in assessing the effects of monetary policy shocks.     

SYNCHRONIZATION OF ECONOMIC SHOCKS BETWEEN GULF COOPERATION COUNCIL AND UNITED STATES,EUROPE, JAPAN,AND OIL MARKET: CHOICE OF EXCHANGE RATE REGIME†

Using a structural vector autoregression (SVAR) with block exogeneity, this study examines the impacts of external shocks originating from the United States, the European Union, Japan, and the oil market as well as those of the regional shocks, on the oil‐rich countries of the Gulf Cooperation Council (GCC), viewed as a prospective monetary union. It takes into account the implications of the shock impacts for selecting an appropriate common exchange rate arrangement. The SVAR variance decomposition and impulse response analyses strongly underscore the relative impacts of the global shocks over the regional ones. The findings imply that the world's two major currencies, the U.S. dollar and the euro, should figure highly in a GCC's common basket of currencies. Accordingly, a transitional movement to a more flexible exchange rate arrangement such as a basket peg may be desirable for these trade‐dependent economies in the long run, as is argued in the optimal currency literature for developing countries. (JEL E52, O52, C22)     

On the feasibility of monetary union: Does it make sense to look for shocks symmetry across countries when none of the countries constitutes an optimum currency area?

Usually, a monetary union is not considered feasible between countries if the correlations of shocks are positive but weak. This may not be so if the country with the larger output gap converges to full-employment equilibrium faster than the country with the smaller gap. We argue that common monetary policy can be destabilizing when countries' responses to non-monetary shocks are perfectly symmetric with a correlation of 1 but exhibit differing investment sensitivities to the real interest rate. We use Canada, Mexico and the United States to test the feasibility of a monetary union by documenting whether: 1) gross investments in Canada and Mexico are equally responsive to the real fund rate, and 2) Canada and Mexico's output growth and inflation respond differently to US monetary policy shocks and oil price shocks. This approach implicitly dictates whether the shocks themselves are symmetric or asymmetric. Using quarterly data and SVAR methodology, we conducted two layers of analysis. We estimated SVARs for the periods 1970–2008, 1970–1990 and 1991–2008 to find that a monetary union is feasible between Canada and the US for the first two sample periods. For Canada and Mexico, we find similar responses of output growth to US monetary policy shocks. We conducted further robustness tests by estimating two identified VARs with common US variables and oil prices for Canada and Mexico to assess commonality in responses to shocks with the US. These results affirm that a monetary union is also feasible between Canada and the US.     

A structural VAR business cycle model for a volatile small open economy

New Zealand is a small economy exposed to a volatile climate, relatively volatile international trade prices, and its exposure to international financial markets has increased markedly since economic reforms in the 1980s. This paper applies identification techniques suggested by Cushman and Zha [Cushman, D.O. and Zha T.A., 1997. Identifying monetary policy in a small open economy under flexible exchange rates, Journal of Monetary Economics, 39, pp. 433–448.], Zha [Zha, T.A., (1999). Block recursion and structural vector autoregression, Journal of Econometrics, 90, pp. 291–316.] and Dungey and Pagan [Dungey, M. and Pagan, A., 2000. A structural VAR model of the Australian economy, The Economic Record, 76, pp. 321–342.] to develop a large four block structural VAR model of the New Zealand business cycle to capture these features. The model reveals that climate and international trade price shocks have been more important sources of business cycles fluctuations than international or domestic financial shocks. Furthermore, the model does not encounter the price and exchange rate puzzles that have bedevilled attempts to identify monetary policy shocks in small open economy SVAR models.     

Monetary transmission mechanisms in a small open economy: a Bayesian structural VAR approach

Abstract This paper develops a Bayesian structural VAR model for Canada in order to estimate the effects of monetary policy shocks, using the overnight rate target as the policy instrument. I allow the policy variable and other home and foreign variables to interact with each other contemporaneously. The key finding is that monetary policy affects the real economy through both the market interest rate and the exchange rate. I also find that the Bank of Canada responds to any home and foreign variables that embodies information about future inflation and that external shocks are an important source of output fluctuations.     

Macroeconomic shocks and stock market returns: the case of Korea

This study examines the effects of macroeconomic shocks on key macro variables, including stock market returns in Korea, using the structural vector autoregression (SVAR) model. We suggest a three-variable SVAR model incorporating inflation, output growth and stock returns. We adopt a nonzero z-ratio restriction for the long-run identifying assumption to allow for economically meaningful relationships among variables. While our results support the negative (positive) relation of demand (supply) shocks to stock returns, we also find that demand shocks influence stock market variance more significantly than supply shocks do. The sub-period analysis finds that global market fluctuations during the global financial crisis have relatively little effect on Korean stock market performance. We also examine a generalized five-variable model that includes the foreign exchange rate and interest rate, confirming the results from the three-variable case.     

A re-examination of the impacts of macroeconomic and financial shocks on real exchange rate fluctuation: evidence from G7 and Asian countries

ABSTRACT

This paper aims to investigate the sources of real exchange rate fluctuation by utilizing sign restrictions in structural vector autoregressive (SVAR) method. Under an agnostic identification scheme, the empirical results show that the delayed overshooting puzzle still exists in response to monetary shock even if price puzzle is ruled out by construction. In contrast, all countries experience a significant initial real depreciation, and then gradually appreciate in response to currency risk premium (CRP) shock. This finding is consistent with Dornbusch’s overshooting model. In addition, I examine the importance of investors’ expectations in determining the short-term variations in the real exchange rate. The results indicate that the CRP and expectation shocks obviously outperformed the demand, supply and monetary shocks in terms of explaining the real exchange rate fluctuation.     

我国货币政策有效性及其与股票市场的交互影响*——基于SVAR模型的实证研究

本文构建以货币政策变量、股票价格变量和宏观经济变量为基础且同时施加有短期和长期约束的结构向量自回归（SVAR）模型,将货币政策与股票市场的当期关系纳入分析,利用1997—2015年的数据,实证检验了我国货币政策和股票市场间的交互作用及其对宏观经济的影响。实证结果表明,现阶段我国货币政策冲击对股票市场没有显著影响,但股票价格冲击在2005年人民币汇率制度改革之后对我国的产出、M2供应及通货膨胀影响的显著性均明显提升。     

The effects of monetary policy using structural factor analysis

The traditional Vector Autoregression (VAR) method is widely used to trace out the effects of monetary policy innovations on the economy. However, this method suffers from the curse of dimensionality, so that in practice VARs are estimated on a limited number of variables, leading to a potential missing information problem. In this article we use the method of structural factor analysis to evaluate the effects of monetary policy on key macroeconomic variables in a data rich environment. This methodology allows us to extract information on monetary policy and its impact on the economy from a much larger data set than is possible with the traditional VAR method. We propose two structural factor models. One is the Structural Factor Augmented Vector Autoregressive (SFAVAR) model and the other is the Structural Factor Vector Autoregressive (SFVAR) model. Compared to the traditional VAR, both models incorporate information from hundreds of data series, series that can be and are monitored by the central bank in setting policy. Moreover, the factors used are structurally meaningful, a feature that adds to the understanding of the ‘black box’ of the monetary transmission mechanism. Both models generate qualitatively reasonable impulse response functions. For the SFVAR model, both the price puzzle and the liquidity puzzle are eliminated.     

The impact of Chinese monetary policy shocks on East and South‐East Asia1

We study the effects of Chinese monetary policy shocks on China's major trading partners in East and South‐East Asia by estimating structural vector autoregressive (SVAR) models for six economies in the region. We find that a monetary expansion in Mainland China leads to an increase in real GDP (temporary) and the price level (permanent) in a number of economies in our sample, most notably in Hong Kong and the Philippines. The impact could result from intertemporal substitution present in a general equilibrium framework, which allows for positive domestic impacts of foreign monetary expansions. Our results emphasize the growing importance of China for its neighbouring economies and the significance of Chinese shocks for the design of monetary policy in Asian economies.     

Full versus quasi MLE for ARMA-GARCH models with infinitely divisible innovations

We compare the backtesting performance of ARMA-GARCH models with the most common types of infinitely divisible innovations, fit with both full maximum likelihood estimation (MLE) and quasi maximum likelihood estimation (QMLE). The innovation types considered are the Gaussian, Student’s t, α-stable, classical tempered stable (CTS), normal tempered stable (NTS) and generalized hyperbolic (GH) distributions. In calm periods of decreasing volatility, MLE and QMLE produce near identical performance in forecasting value-at-risk (VaR) and conditional value-at-risk (CVaR). In more volatile periods, QMLE can actually produce superior performance for CTS, NTS and α-stable innovations. While the t-ARMA-GARCH model has the fewest number of VaR violations, rejections by the Kupeic and Berkowitz tests suggest excessively large forecasted losses. The α-stable, CTS and NTS innovations compare favourably, with the latter two also allowing for option pricing under a single market model.     

Real options or disaster risk? Distinguishing uncertainty effects on investment

ABSTRACT

Motivated by the fact that uncertainty shocks are a countercyclical phenomenon, this article takes a deeper look at the nature of uncertainty shocks in times of crisis and its effect on the real economy. We distinguish between volatility and disaster risk shocks and specify the consequences of these shock specifications on investment decisions. We first analyse the different impact of both shocks within a real options framework. Our theoretical results show that the effects of the two shocks are different, especially concerning disinvestment and the mid-term investment response. Second, we perform structural vector autoregression (SVAR) estimations on different country data sets. The SVAR estimations confirm our theoretical hypothesis: countries more prone to states of disaster do not show the usual real option pattern of investment to an uncertainty shock.     

Total factor productivity and the propagation of shocks: Empirical evidence and implications for the business cycle

Using a robust sign restrictions approach, we study the response of total factor productivity (TFP) to structural shocks in a VAR framework. We find that TFP increases in response to adverse supply, demand, and wage mark-up shocks. Results for monetary policy shocks are insignificant. Following an adverse technology shock and reductions in government spending, TFP declines. Overall, we conclude that TFP fluctuates endogenously over the business cycle, a feature of the data that is not present in standard DSGE models.     

On the Effects of Inflation Shocks in a Small Open Economy

The effects of monetary policies remain always an important topic in macroeconomics. In the literature (closed and open economy), there is no theoretical as well as empirical consensus regarding the effects of monetary policies. In this paper we examine the real effects of inflation in an open economy. Australia is a classic example of a small open economy and is known to exercise inflation targeting. Using quarterly data from Australia and employing vector autoregressive (VAR) analysis, we provide evidence that inflation, both in the short and long run, negatively affects durable and non‐durable consumption and investment, and has a positive effect on the current account. Further, we show that consumption of durable goods is more sensitive than the consumption of non‐durables during the initial periods following inflationary shocks.     

Assessing monetary policy in the euro area: a factor-augmented VAR approach

In order to overcome the omitted information problem of small-scale Vector Autoregression (VAR) models, this study combines the VAR methodology with dynamic factor analysis and assesses the effects of monetary policy shocks in the euro area in the period during which there is a single monetary policy. Using the Factor-Augmented Vector Autoregressive (FAVAR) approach of Bernanke et al. (2005 Bernanke, B, Boivin, J and Eliasz, P. 2005. Measuring the effects of monetary policy: a factor-augmented vector autoregressive (FAVAR) approach. The Quarterly Journal of Economics, 120: 387–422. [Crossref], [Web of Science ®] , [Google Scholar]), we summarize the information contained in a large set of macroeconomic time series with a small number of estimated factors and use them as regressors in recursive VARs to evaluate the impact of the nonsystematic component of the European Central Bank's (ECB's) actions. Overall, our results suggest that the inclusion of factors in the VAR allows us to obtain a more coherent picture of the effects of monetary policy innovations, both by achieving responses easier to understand from the theoretical point of view and by increasing the precision of such responses. Moreover, this framework allows us to compute impulse-response functions for all the variables included in the panel, thereby providing a more complete depiction of the effects of policy disturbances. However, the extra information generated by the FAVAR also delivers some puzzling responses, in particular those relating to exchange rates.     

The Effects of Monetary Policy Shocks in the USA: A Forecast‐Augmented VAR Approach

This paper formulates a forward‐looking monetary policy function for the USA in a structural vector autoregression (VAR) model, by using forecasts of key macroeconomic variables, in addition to the ex post realised variables used in a standard VAR. Since this forecast‐augmented VAR (FOAVAR) uses both forecasted and realised variables, and the standard VAR uses only realised variables, the standard VAR is nested in the FOAVAR. I find that the Fed responds to forecasted macroeconomic variables more significantly than realised variables. I also find that the monetary policy shock in the FOAVAR generates impulse responses of variables that are consistent with the predictions of economic theories, while the policy shock in the standard VAR causes a price puzzle: an increase in the price level due to a contractionary policy shock. These results suggest that a monetary policy function identified in a standard VAR, by using only realised macroeconomic variables, may incorrectly represent the Fed's policy function.     

Market concentration, macroeconomic uncertainty and monetary policy

This paper studies the effect of market structure and macroeconomic uncertainty on the transmission of monetary policy. We motivate our analysis with a simple model which predicts that: (1) investment and production in more concentrated sectors are more affected by demand shocks and (2) high uncertainty makes investment and production more sensitive to demand shocks. The empirical analysis estimates the effect of monetary shocks on sectoral output for different sectors in the US using a structural vector autoregressive (VAR) approach. The results are generally consistent with the theoretical predictions.     

The effects of monetary policy in the Czech Republic: an empirical study

In this paper, we examine the effects of Czech monetary policy on the economy within the vector auto regression (VAR), structural VAR, Bayesian VAR with sign restrictions, and factor-augmented VAR, frameworks. We document a well-functioning transmission mechanism similar to the euro area countries, especially in terms of persistence of monetary policy shocks. Subject to various sensitivity tests, we find that a contractionary monetary policy shock has a negative effect on the degree of economic activity and the price level, both with a peak response after one year or so. Regarding prices at the sectoral level, tradables adjust faster than non-tradables, which is in line with microeconomic evidence on price stickiness. There is no price puzzle, as our data come from a single monetary policy regime. There is a rationale in using the real-time output gap instead of current GDP growth, as using the former results in much more precise estimates. The results indicate a rather persistent appreciation of the domestic currency after a monetary tightening, with a gradual depreciation afterwards.     

A New Keynesian SVAR model of the Australian economy

We estimate an SVAR model for the Australian economy based on an open economy New Keynesian model that accounts for the forward-looking behaviour exhibited by economic agents. Deep structural parameters are identified by placing exclusion restrictions on the VAR residuals and the covariance matrix. Dynamic responses show no price and exchange rate puzzles and indicate that the Reserve Bank of Australia (RBA) stabilises output fluctuations in the short run while maintaining a medium-run inflation target since 1984. Aggregate demand shocks are found to be driven by external demands. The RBA exercises caution in responding to aggregate supply shocks.