Innovation Mechanism in Monetary Policy Forecasting: Unification of all Macroeconomic Puzzles in SVAR Model

The article is devoted to developing a forecasting mechanism unifying all macroeconomic puzzles, which violate fundamental macroeconomic relationships among variables of the monetary transmission mechanism in Ukraine. The violations mentioned above caused by breaking one-law price (PPP puzzle), uncovered interest rates rule (UIP puzzle), plausible emergence of new sophisticated financial instruments, and causality of international risk-sharing conditions under the financial capital spillover. The authors calculated the residuals in the VAR model of monetary transmission mechanism (MTM) to analyze the correlations between shocks and disturbances in these variables. Furtherly these correlations were put in constructing the restriction matrix for building a structural vector autoregressive model. The correlations between shocks and disturbances were employed for estimating the impulse response functions used for determining the duration of half-life shocks for the real exchange rate. The obtained results allowed noticing that relationships between macroeconomic variables in the monetary transmission mechanism were not similar if considering the established foreign exchange arrangement. In particular, during 2007-2020, relationships among MTM variables were violated. Besides, the half-life duration of the real exchange rate was far longer. While in cases for Ukraine before switching to floating exchange rate regime and after it became less explicit and half-lives were shorter. The findings allowed confirming the impact of the currency arrangement switching on violation of traditional linkages between the variables of foreign exchange rate channel of MTM. Thus, it showed that during the fixed arrangement, absolutely all reactions were violated. Although after the introduction of a flexible exchange rate, the sign of REER correlation with foreign trade terms has changed to positive and more strengthened. Therefore, it has demonstrated a positive impact on the dynamics of real GDP and lower inflation. The findings of the current study could be used to improve existed methodical approaches for establishing structural constraints on variables responses to the shock of the exchange rate. The algorithm for designing optimal monetary policy strategies could take place in empirical data and forecasting exchange rate volatility.Keywords: PPP puzzle, UIP puzzle, MTM, financial innovations, REER, SVAR.