DP1743 Measuring Monetary Policy with VAR Models: An Evaluation

Author(s): Fabio-Cesare Bagliano, Carlo A. Favero
Publication Date: November 1997
Keyword(s): monetary transmission, VAR models
JEL(s): E44, E52
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=1743

This paper evaluates VAR models designed to analyse the monetary policy transmission mechanism in the United States by considering three issues: specification, identification, and the effect of the omission of the long-term interest rate. Specification analysis suggests that only VAR models estimated on a single monetary regime feature parameter stability and do not show signs of mis-specification. The identification analysis shows that VAR-based monetary policy shocks and policy disturbances identified from alternative sources are not highly correlated but yield similar descriptions of the monetary transmission mechanism. Lastly, the inclusion of the long-term interest rate in a benchmark VAR delivers a more precise estimation of the structural parameters capturing behaviour in the market for reserves and shows that contemporaneous fluctuations in long-term interest rates are an important determinant of the monetary authority?s reaction function.