Still Puzzling: Evaluating the Price Puzzle in an Empirically Identified Structural Vector Autoregression

55 Pages Posted: 19 May 2009

See all articles by Selva Demiralp

Selva Demiralp

Koc University - Department of Economics

Kevin D. Hoover

Duke University - Departments of Economics and Philosophy

Stephen J. Perez

California State University, Sacramento - Department of Economics

Date Written: May 18, 2009

Abstract

The price puzzle is the association in a structural vector autoregression (SVAR) of a contractionary shock to monetary policy with persistent increases in the price level. Various explanations have been investigated separately in the framework of small SVARs without any common set of variables and with ad hoc and casually justified identification schemes. In contrast, here it is addressed in a rich 12-variable SVAR in which various factors that have been mooted as solutions are considered jointly. SVARs for the pre-1980 and post-1990 periods are identified empirically using a graph-theoretic causal search algorithm combined with formal tests of the implied overidentifying restrictions. The transmission mechanism of monetary policy to prices remains puzzling. Whether a price puzzle exists in the pre-1980 depends on whether monetary-policy actions are adequately characterized by movements in the Federal funds rate. If so, there is a price puzzle. But if monetary policy is better characterized through movements in reserves, then there is no price puzzle. In the later period, monetary policy is well characterized by movements in the Federal funds rate, but the response of prices is statistically insignificant. Commonly suggested resolutions, including the inclusion of commodity prices, measures of output gaps, and fuller specification of monetary policy are shown to have causal implications inconsistent with the data. Nevertheless, the evidence suggests that further investigation of the role of the output gap and monetary policy is warranted.

Keywords: price puzzle, monetary policy, inflation, graph theory, causality, causal search, PC algorithm, output gap, SVAR, cost channel, commodity prices, transmission mechanism

JEL Classification: C32, C51, E32, E44, E51

Suggested Citation

Demiralp, Selva and Hoover, Kevin D. and Perez, Stephen J., Still Puzzling: Evaluating the Price Puzzle in an Empirically Identified Structural Vector Autoregression (May 18, 2009). Available at SSRN: https://ssrn.com/abstract=1406643 or http://dx.doi.org/10.2139/ssrn.1406643

Selva Demiralp

Koc University - Department of Economics ( email )

Rumeli Feneri Yolu
Sariyer 80910 Istanbul
Turkey
+212 338 1842 (Phone)

Kevin D. Hoover (Contact Author)

Duke University - Departments of Economics and Philosophy ( email )

213 Social Sciences Building
Box 90097
Durham, NC 27708-0204
United States

Stephen J. Perez

California State University, Sacramento - Department of Economics ( email )

6000 J Street
Sacramento, CA 95819-6082
United States
916-278-6919 (Phone)
916-278-5768 (Fax)

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