Large Datasets, Small Models and Monetary Policy in Europe

Carlo Favero () and Massimiliano Marcellino

No 3098, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Nowadays a considerable amount of information on the behaviour of the economy is readily available, in the form of large datasets of macroeconomic variables. Central bankers can be expected to base their decisions on this very large information set. Yet the academic profession has shown a clear preference for using small models to highlight stylized facts and to implement policy simulation exercises. Omitted information is then a potentially relevant problem. Recent time-series techniques for the analysis of large datasets have shown how vast an amount of information can be captured by few factors. In this paper we combine factors extracted from large datasets with more traditional small-scale models to analyse monetary policy in Europe. In particular, we model hundreds of macroeconomic variables with a dynamic factor model, and summarize their informational content with a few estimated factors. These factors are then used as instruments in the estimation of forward-looking Taylor rules, and as additional regressors in structural VARs. The latter are then used to evaluate the effects of unexpected and systematic monetary policy.

Keywords: Monetary policy; Small models; Dynamic factors (search for similar items in EconPapers)
JEL-codes: E50 E52 E58 (search for similar items in EconPapers)
Date: 2001-12
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Citations: View citations in EconPapers (31)

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