Anticipatory Monetary Policy and the Price Puzzle
Reserve Bank of Australia, RDP 2017-02
35 Pages Posted: 22 May 2017
Date Written: May 22, 2017
Vector Autoregressions often find that inflation increases in response to a tightening in monetary policy, although standard macroeconomics predicts the opposite. This ‘price puzzle’ is commonly thought to reflect interest rates being tightened in anticipation of future inflation, reflecting information possessed by policy-makers beyond that contained in the model. Romer and Romer (2004) and Cloyne and Hürtgen (2016) successfully remove the price puzzle from US and UK data respectively by purging the cash rate of systematic policy responses to central bank forecasts. We find that this approach does not work for Australia under a wide range of specifications. This suggests that VARs may not be the most reliable way to analyse monetary policy.
Keywords: price puzzle, monetary policy, Vector Autoregressions
JEL Classification: E31, E52
Suggested Citation: Suggested Citation