Modeling Monetary Transmission in Switzerland with a Structural Cointegrated VAR Model

Katrin Assenmacher-Wesche

doi:10.1007/bf03399253

Abstract

SummaryThis paper examines the transmission of monetary policy in Switzerland using a structural cointegrated VAR model that includes real money, real output, a long and short-term interest rate, inflation, the exchange rate and a foreign interest rate as endogenous variables and oil prices as exogenous variables. The model takes account of five cointegrating relations that are interpreted as money demand, the real interest rate, the term spread, uncovered interest parity and an aggregate demand schedule. Recursive analysis confirms that the model remains stable after the adoption of a new monetary policy framework of the Swiss National Bank in 2000. After identifying a monetary policy shock, the model is used for impulse-response analysis. We obtain plausible responses of inflation and output to a monetary policy shock but despite the inclusion of money and oil prices an exchange rate puzzle remains present.

Highlights

Central banks are interested in learning about the effect of a change in their policy rate – typically a short-term interest rate – on their target variables, inflation and output growth
The long-term interest rate and the exchange rate are included as information variables that are affected by all other variables during the current period and ordered after the monetary policy equations
In this paper we study a cointegrating VAR model of the monetary transmission mechanism in Switzerland, which incorporates inflation, real gross domestic product (GDP), real M2, a short and a long-term interest rate, the exchange rate and the foreign interest rate as endogenous variables and the oil price as exogenous variable

Summary

Introduction

Central banks are interested in learning about the effect of a change in their policy rate – typically a short-term interest rate – on their target variables, inflation and output growth. This paper investigates the transmission of monetary policy shocks in a structural cointegrated vector-autoregressive (VAR) model for Switzerland that allows us to impose and test a long-run structure as well as a short-run structure on the data. The five cointegrating relations among the variables in the model are interpreted as capturing money demand, the real interest rate, a term spread, uncovered interest parity and an output demand schedule. To investigate whether economic relations have remained stable after the Swiss National Bank (SNB) adopted a new monetary policy framework in 2000, we perform stability tests and recursive analyses.

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