Assessing the Transmission of Monetary Policy Shocks Using Dynamic Factor Models

37 Pages Posted: 26 Aug 2009 Last revised: 27 Feb 2011

See all articles by Dimitris Korobilis

Dimitris Korobilis

University of Glasgow - Adam Smith Business School

Date Written: August 24, 2009

Abstract

This paper extends the current literature which questions the stability of the monetary transmission mechanism, by proposing a factor-augmented vector autoregressive (VAR) model with time-varying coefficients and stochastic volatility. The VAR coefficients and error covariances may change gradually in every period or be subject to abrupt breaks. The model is applied to 143 post-World War II quarterly variables fully describing the US economy. I show that both endogenous and exogenous shocks to the US economy resulted in the high inflation volatility during the 1970s and early 1980s. The time-varying factor augmented VAR produces impulse responses of inflation which significantly reduce the price puzzle. Impulse responses of other indicators of the economy show that the most notable changes in the transmission of unanticipated monetary policy shocks occurred for GDP, investment, exchange rates and money.

Keywords: Structural FAVAR, time varying parameter model, monetary policy

JEL Classification: C11, C32, E52

Suggested Citation

Korobilis, Dimitris, Assessing the Transmission of Monetary Policy Shocks Using Dynamic Factor Models (August 24, 2009). Available at SSRN: https://ssrn.com/abstract=1461152 or http://dx.doi.org/10.2139/ssrn.1461152

Dimitris Korobilis (Contact Author)

University of Glasgow - Adam Smith Business School ( email )

40 University Avenue
Gilbert Scott Building
Glasgow, Scotland G12 8QQ
United Kingdom

HOME PAGE: http://https://sites.google.com/site/dimitriskorobilis/

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