THE PRICE PUZZLE AND VAR IDENTIFICATION

Arturo Estrella

Macroeconomic Dynamics, 2015, vol. 19, issue 8, 1880-1887

Abstract: In structural VARs, unexpected monetary tightening often leads to the price puzzle, a counterintuitive increase in inflation in the impulse response function. The identification of impulse responses requires at least a minimal set of structural assumptions, and models exhibiting the price puzzle typically use standard assumptions focusing mainly on relationships among contemporaneous disturbances. This note uses a well-established stylized fact, the long lags of monetary policy, to motivate a simple additional identifying assumption. The assumption eliminates a single term in one equation of the reduced form, and with it the price puzzle.

Date: 2015
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