Measuring Monetary Policy with VAR Models: an Evaluation

Fabio C. Bagliano () and Carlo Favero ()

No 132, Working Papers from IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University

Abstract: This paper evaluates VAR models designed to analyze 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 suggest that only VAR models estimated on a single monetary regime feature parameters 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 yeld 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.

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Related works:
Working Paper: Measuring Monetary Policy with VAR Models: An Evaluation (1997)
Journal Article: Measuring monetary policy with VAR models: An evaluation (1998)
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