Modified Blocked Effect Method to Test Strength of Monetary Policy Transmission Channels

Abstract

The Ramey (1993) method (label here “Blocked Effect Approach”) is widely used in the empirical papers on monetary policy transmission mechanism channels. Its broad application is due to the relatively simple way, providing a criteria for identifying monetary transmission channels. In doing so it imposes too many restrictions on the parameters of the underlying VAR system, typically used for this type of empirical analysis. However, “blocked effect approach” may not coincide with the theoretical restrictions required by a proper definition of a monetary transmission channel. In this paper an attempt is made to define a statistical procedure to remedy certain shortcomings of this method. This modification also relaxes the unnecessary restriction and direct to a more precise measurement of channel strength. Finally we apply this method to credit channel of monetary policy transmission in the US economy. The modified blocked effect can distinguish channel strength between different variables in different sub-sample periods. Our empirical results show that it is an active channel of monetary policy; it effect output in the short-run and inflation with 12 quarters lag.