Abstract
A structural factor model for 112 US monthly macroeconomic series is used to study the effects of monetary policy. Monetary policy shocks are identified using a standard recursive scheme, in which the impact effects on both industrial production and prices are zero. The main findings are the following. First, the maximal effect on bilateral real exchange rates is observed on impact, so that the “delayed overshooting” puzzle disappears. Second, after a contractionary shock prices fall at all horizons, so that the price puzzle is not there. Finally, monetary policy has a sizable effect on both real and nominal variables.
Highlights
Mainstream theory predicts that a monetary policy tightening reduces prices and produces an immediate appreciation of the domestic currency followed by a depreciation
Eichenbaum and Evans (1995) and Grilli and Roubini (1995) find that exchange rates react with a long delay, being barely affected on impact, a result known as the delayed overshooting puzzle
This paper studies the effects of monetary policy shocks within a structural factor model approach
Summary
Mainstream theory predicts that a monetary policy tightening reduces prices and produces an immediate appreciation of the domestic currency followed by a depreciation. Even including commodity prices, the estimated reaction of prices to monetary policy is negligible in size and disproportionately small as compared to the large response of output (see e.g. Christiano, Eichenbaum, Evans, 1999, CEE on) This finding, somewhat understated in the literature, can hardly be reconciled with mainstream theories. A relevant stream of research has focused on models designed to handle a large amount of information, i.e. the generalized (or approximate) dynamic factor models (early works are Forni, et al, 2000, 2005, Forni and Lippi, 2001, Stock and Watson, 2002a, 2002b, Bai and Ng, 2002, Bai, 2003) Such models, successfully used for forecasting and the construction of coincident indicators, have recently been proposed for structural macroeconomic analysis, (Forni, Giannone, Lippi and Reichlin, (2009, FGLR on).
Sign-in/Register to view highlights & summary Sign-in/Register to access full text options 
Free) 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a call
