Forward-Looking Information in VAR Models and the Price Puzzle

Sophocles N. Brissimis () and Nicholas Magginas
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Nicholas Magginas: Athens University of Economics and Business and National Bank of Greece

No 10, Working Papers from Bank of Greece

Abstract: In this paper we suggest a VAR specification that proves to be successful in resolving the price puzzle featuring in VARs used for monetary policy analysis. We show that augmenting a standard VAR with a small number of variables that have forward-looking informational content is capable of producing theory-consistent responses to monetary policy shocks. The VAR is estimated for the US with data covering the period 1989-2001, which is characterized by a relatively homogeneous monetary policy regime and a pronounced price puzzle in standard VAR specifications. Most important among these forward-looking variables are the federal funds rate future reflecting expectations of future monetary policy and a leading composite indicator providing information about near-term developments in economic activity. In view of the increasing ability of financial markets to better predict monetary policy movements, financial asset prices, such as the federal funds rate futures, are ideal candidates for incorporating parsimoniously a large amount of information into a lowdimension VAR.

Keywords: Monetary transmission mechanism; VAR models; Fed funds futures; price puzzle (search for similar items in EconPapers)
JEL-codes: E44 E52 F41 G1 (search for similar items in EconPapers)
Date: 2004-02
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Published in Journal of Monetary Economics, 2006, 53(6), pp 1225-1234

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Journal Article: Forward-looking information in VAR models and the price puzzle (2006)
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Persistent link: http://EconPapers.repec.org/RePEc:bog:wpaper:10

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