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Monetary policy shocks and Cholesky VARs: an assessment for the Euro area

Efrem Castelnuovo ()

Empirical Economics, 2016, vol. 50, issue 2, 383-414

Abstract: Abstract An estimated monetary policy VAR with 1993:IV–2008:III Euro data returns an insignificant response of inflation and a borderline significant reaction of the output gap to monetary policy shocks identified with the widely employed Cholesky restrictions. We replicate this evidence with a Monte Carlo exercise, in which the true responses of inflation and the output gap, according to an estimated DSGE model which we use as data-generating process, are negative. Consequently, insignificant macroeconomic reactions to policy shocks as documented by a small-scale Cholesky-VAR for the Euro area do not necessarily point to monetary policy neutrality. Differently, the Cholesky-VAR evidence may very well be due to false short-run zero-restrictions. A data-driven discussion on this reading of the drivers of our Cholesky-VAR impulse responses versus alternative interpretations such as omitted factors and structural breaks is proposed.

Keywords: Monetary policy shocks; Cholesky VARs; Dynamic stochastic general equilibrium models; Bayesian estimation; Euro area (search for similar items in EconPapers)
JEL-codes: C22 E47 E52 (search for similar items in EconPapers)
Date: 2016
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