Monetary Policy, External Instruments and Heteroskedasticity
35 Pages Posted: 8 Aug 2018
Date Written: July 2018
We develop a vector autoregressive framework for combining the information in an external instrument with the information in the second moments of the data to identify latent monetary shocks in the United States. We show that the framework improves the identification of the structural model and allows testing the validity of instruments proposed in the literature. Using a valid instrument, we then document that surprise monetary contractions lead to a medium-sized significant decline in economic activity, that the contractionary effect is also present during the great moderation, and that the role of monetary shocks in driving real and financial fluctuations is small in low and big in high volatility regimes.
Keywords: Monetary policy, structural vector autoregressions, identification with external instruments, heteroskedasticity, Markov switching
JEL Classification: E52,C32,E58,E32
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