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Assessing monetary policy in the euro area: a factor-augmented VAR approach

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  • Rita Soares

Abstract

In order to overcome the omitted information problem of small-scale Vector Autoregression (VAR) models, this study combines the VAR methodology with dynamic factor analysis and assesses the effects of monetary policy shocks in the euro area in the period during which there is a single monetary policy. Using the Factor-Augmented Vector Autoregressive (FAVAR) approach of Bernanke et al . (2005), we summarize the information contained in a large set of macroeconomic time series with a small number of estimated factors and use them as regressors in recursive VARs to evaluate the impact of the nonsystematic component of the European Central Bank's (ECB's) actions. Overall, our results suggest that the inclusion of factors in the VAR allows us to obtain a more coherent picture of the effects of monetary policy innovations, both by achieving responses easier to understand from the theoretical point of view and by increasing the precision of such responses. Moreover, this framework allows us to compute impulse-response functions for all the variables included in the panel, thereby providing a more complete depiction of the effects of policy disturbances. However, the extra information generated by the FAVAR also delivers some puzzling responses, in particular those relating to exchange rates.

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  • Rita Soares, 2013. "Assessing monetary policy in the euro area: a factor-augmented VAR approach," Applied Economics, Taylor & Francis Journals, vol. 45(19), pages 2724-2744, July.
    • Handle: RePEc:taf:applec:v:45:y:2013:i:19:p:2724-2744
    DOI: 10.1080/00036846.2012.676736
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    References listed on IDEAS

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    1. Ricardo Reis & Mark W. Watson, 2010. "Relative Goods' Prices, Pure Inflation, and the Phillips Correlation," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(3), pages 128-157, July.
    2. Gert Peersman, 2004. "The Transmission of Monetary Policy in the Euro Area: Are the Effects Different Across Countries?," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 66(3), pages 285-308, July.
    3. James H. Stock & Mark W. Watson, 2005. "Implications of Dynamic Factor Models for VAR Analysis," NBER Working Papers 11467, National Bureau of Economic Research, Inc.
    4. Blaes, Barno, 2009. "Money and monetary policy transmission in the euro area: evidence from FAVAR- and VAR approaches," Discussion Paper Series 1: Economic Studies 2009,18, Deutsche Bundesbank.
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    Cited by:

    1. Jackson, Laura E. & Owyang, Michael T. & Zubairy, Sarah, 2018. "Debt and stabilization policy: Evidence from a Euro Area FAVAR," Journal of Economic Dynamics and Control, Elsevier, vol. 93(C), pages 67-91.
    2. Olli-Matti Juhani Laine, 2020. "The effect of the ECB’s conventional monetary policy on the real economy: FAVAR-approach," Empirical Economics, Springer, vol. 59(6), pages 2899-2924, December.
    3. Reza Najarzadeh & Alireza Keikha & Hassan Heydari, 2021. "Dynamics of consumption distribution and economic fluctuations," Economic Change and Restructuring, Springer, vol. 54(3), pages 847-876, August.
    4. E. Kilic & S. Cankaya, 2016. "Consumer confidence and economic activity: a factor augmented VAR approach," Applied Economics, Taylor & Francis Journals, vol. 48(32), pages 3062-3080, July.
    5. Serdar Varlik & M. Hakan Berument, 2020. "Monetary policy under a multiple‐tool environment," Bulletin of Economic Research, Wiley Blackwell, vol. 72(3), pages 225-250, July.
    6. Laine, Olli-Matti, 2022. "Evidence about the transmission of monetary policy," Bank of Finland Scientific Monographs, Bank of Finland, volume 0, number e53, July.
    7. Serati, Massimiliano & Venegoni, Andrea, 2019. "The cross-country impact of ECB policies: Asymmetries in – Asymmetries out?," Journal of International Money and Finance, Elsevier, vol. 90(C), pages 118-141.
    8. Babecká Kucharčuková, Oxana & Claeys, Peter & Vašíček, Bořek, 2016. "Spillover of the ECB's monetary policy outside the euro area: How different is conventional from unconventional policy?," Journal of Policy Modeling, Elsevier, vol. 38(2), pages 199-225.
    9. repec:zbw:bofrdp:2018_012 is not listed on IDEAS
    10. Anttila, Juho, 2018. "Measuring the effects of conventional and unconventional monetary policy in the euro area," Bank of Finland Research Discussion Papers 12/2018, Bank of Finland.
    11. Anttila, Juho, 2018. "Measuring the effects of conventional and unconventional monetary policy in the euro area," Research Discussion Papers 12/2018, Bank of Finland.

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