VAR meets DSGE: Uncovering the Monetary Transmission Mechanism in Low-Income Countries

Grace Li, Stephen O'Connell, Christopher Adam, Andrew Berg () and Peter Montiel

No 2016/090, IMF Working Papers from International Monetary Fund

Abstract: VAR methods suggest that the monetary transmission mechanism may be weak and unreliable in low-income countries (LICs). But are structural VARs identified via short-run restrictions capable of detecting a transmission mechanism when one exists, under research conditions typical of these countries? Using small DSGEs as data-generating processes, we assess the impact on VAR-based inference of short data samples, measurement error, high-frequency supply shocks, and other features of the LIC environment. The impact of these features on finite-sample bias appears to be relatively modest when identification is valid—a strong caveat, especially in LICs. However, many of these features undermine the precision of estimated impulse responses to monetary policy shocks, and cumulatively they suggest that “insignificant” results can be expected even when the underlying transmission mechanism is strong.

Keywords: WP; monetary policy; interest rate; transmission mechanism; Monetary Transmission Mechanism; Low Income Countries; Vector Autoregression Methods; Monte Carlo Methods; monetary policy shock; LIC environment; GDP gap; inflation rate; interest rate target; estimation environment; monetary policy effect; research environment; LIC context; features of the estimation environment; exchange-rate elasticity; monetary policy rule; Vector autoregression; Dynamic stochastic general equilibrium models; Structural vector autoregression; Supply shocks; Africa (search for similar items in EconPapers)
Pages: 45
Date: 2016-04-11
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Citations: View citations in EconPapers (4)

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