Discussion paper

DP4106 Identifying the Monetary Transmission Mechanism Using Structural Breaks

We propose a method for estimating a subset of the parameters of a structural rational expectations model by exploiting changes in policy. We define a class of models, midway between a vector autoregression and a structural model, that we call the recoverable structure. We provide an application of our method by estimating the parameters of a three equation model of the monetary transmission mechanism using data from 1970:Q1 to 1999:Q4. We estimate a vector autoregression and find that the parameters of this VAR are unstable. However, using our proposed identification method we are able to attribute instability in the parameters of the VAR solely to changes in the parameters of the policy rule. We recover parameter estimates of the recoverable structure and we demonstrate that these parameters are invariant to changes in policy. Since the recoverable structure includes future expectations as explanatory variables our parameter estimates are not subject to the Lucas Critique of Econometric Policy Evaluation.


Farmer, R and A Beyer (2003), ‘DP4106 Identifying the Monetary Transmission Mechanism Using Structural Breaks‘, CEPR Discussion Paper No. 4106. CEPR Press, Paris & London. https://cepr.org/publications/dp4106