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An Alternative Explanation of the Price Puzzle

Author

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  • Giordani, Paolo

    (Stockholm School of Economics, Department of Economics)

Abstract

This paper proposes a simple explanation for the frequent appearance of a price puzzle in VARs designed for monetary policy analysis. It suggests that the best method of solving the puzzle implies a close connection between theory and empirics rather than the introduction of a commodity price. It proves that the omission of a measure of output gap (or potential output) spuriously produces a price puzzle in a wide class of commonly used models. This can happen even if the model admits a triangular identification and if the forecasts produced by the misspecified VAR are optimal. In the framework of a model due to Svensson, the omission of a measure of output gap is shown to generate several other incorrect conclusions. When the model is tested on US data, all predictions are supported.

Suggested Citation

  • Giordani, Paolo, 2001. "An Alternative Explanation of the Price Puzzle," Working Paper Series 125, Sveriges Riksbank (Central Bank of Sweden).
    • Handle: RePEc:hhs:rbnkwp:0125
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    References listed on IDEAS

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    More about this item

    Keywords

    VAR; monetary policy; misspecification; output gap; technology shocks.;
    All these keywords.

    JEL classification:

    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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