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

46 Pages Posted: 9 Dec 2016

See all articles by Bin (Grace) Li

Bin (Grace) Li

International Monetary Fund

Stephen A. O'Connell

Swarthmore College - Economics Department; University of Oxford - Centre for Study of African Economics

Christopher Scott Adam

University of Oxford

Andrew Berg

International Monetary Fund (IMF) - Developing Country Studies Division

Peter J. Montiel

Williams College - Department of Economics

Date Written: April 2016

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: Monetary transmission mechanism, Low-income developing countries, Variables (Mathematics), Vector autoregression, General equilibrium models, Monetary Transmission Mechanism; Monetary Policy; Low Income Countries; VectorAutoregression Methods; Monte Carlo Methods

JEL Classification: E47, E52, O11, O23

Suggested Citation

Li, Bin (Grace) and O'Connell, Stephen A. and Adam, Christopher Scott and Berg, Andrew and Montiel, Peter J., VAR Meets DSGE: Uncovering the Monetary Transmission Mechanism in Low-Income Countries (April 2016). IMF Working Paper No. 16/90. Available at SSRN: https://ssrn.com/abstract=2882654

Bin (Grace) Li (Contact Author)

International Monetary Fund ( email )

700 19th Street NW
Washington, DC 20431
United States

HOME PAGE: http://binli.economics.googlepages.com/

Stephen A. O'Connell

Swarthmore College - Economics Department ( email )

Swarthmore, PA 19081
United States
610-328-8107 (Phone)
610-328-7352 (Fax)

HOME PAGE: http://www.swarthmore.edu/SocSci/soconne1/

University of Oxford - Centre for Study of African Economics

Wellington Square
Oxford OX1 3JP
United Kingdom

Christopher Scott Adam

University of Oxford ( email )

Oxford
United Kingdom

Andrew Berg

International Monetary Fund (IMF) - Developing Country Studies Division ( email )

700 19th Street NW
Washington, DC 20431
United States
202-623-8843 (Phone)
202-589-8843 (Fax)

Peter J. Montiel

Williams College - Department of Economics ( email )

Fernald House
Office: Fernald 14
Williamstown, MA 01267
United States
413-597-2103 (Phone)
413-597-4045 (Fax)

HOME PAGE: http://www.williams.edu/Economics/faculty/montiel.htm

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