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The Effects of Monetary Policy Shocks in the USA : A Forecast‐Augmented VAR Approach
Author(s) -
Bhuiyan Rokon
Publication year - 2014
Publication title -
australian economic papers
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.351
H-Index - 15
eISSN - 1467-8454
pISSN - 0004-900X
DOI - 10.1111/1467-8454.12033
Subject(s) - vector autoregression , economics , monetary policy , shock (circulatory) , impulse response , econometrics , structural vector autoregression , variable (mathematics) , macroeconomics , mathematics , medicine , mathematical analysis
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.