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In Discussion Paper No. 1219, Research Fellow Stefan Gerlach
and Frank Smets use structural vector autoregressions, including
real GDP, consumer prices and a short-term interest rate, to study the
monetary transmission mechanism in the G-7 countries between 1979-93.
Monetary policy shocks are identified by assuming that they do not
affect real output instantaneously or in the long run. The incorporation
of three variables in the estimated models imply that at most three
structural shocks can be identified. In order to distinguish between
these disturbances, a combination of the following short- and long-run
restrictions is used: the long-run Phillips curve is vertical; and
monetary policy shocks do not affect output in the quarter they occur.
By using these restrictions, more credible estimates of the different
shocks are obtained than by using solely short- or long-run
restrictions. In particular, the finding of the so-called price puzzle,
which is common to VAR studies using only short-run restrictions,
disappears when aggregate supply shocks are identified using long-run
restrictions. The empirical part of the paper studies the responses of output, prices and real and nominal interest rates to the three shocks; reviews the relative importance of the shocks in accounting for the forecast errors of the different variables; and assesses the relative importance of shocks in different historical episodes. Moreover, the authors simulate the effects on output and prices of a 100 basis points increase in short-term interest rates, maintained for eight quarters. The Monetary Transmission Mechanism: Evidence from the G-7 Countries Stefan Gerlach and Frank Smets Discussion Paper No. 1219, July 1995 (IM) |