Monetary policy shocks and financial conditions: A Monte Carlo experiment

Efrem Castelnuovo

Journal of International Money and Finance, 2013, vol. 32, issue C, 282-303

Abstract: The effects of monetary policy shocks on financial conditions are often estimated by appealing to recursive Vector AutoRegressions (VARs). We assess the ability of this class of VARs to recover the true effects of a monetary policy shock via a Monte Carlo experiment in which the Data Generating Process is a Dynamic Stochastic General Equilibrium (DSGE) model featuring macro-finance interactions and estimated with U.S. quarterly data. Our DSGE model predicts a negative and significant reaction of financial conditions to an unexpected monetary policy tightening. We point out that such reaction is just overlooked by recursive VARs. Moreover, we show that Cholesky-VARs may substantially underestimate the welfare costs due to macroeconomic fluctuations.

Keywords: Kansas City Financial Stress Index; Financial–macroeconomic interactions in a DSGE model; Monetary policy shock; Cholesky-VARs; Monte Carlo exercises (search for similar items in EconPapers)
JEL-codes: E32 E44 (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (14)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:32:y:2013:i:c:p:282-303

DOI: 10.1016/j.jimonfin.2012.04.011

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