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Modest Macroeconomic Effects of Monetary Policy Shocks during the Great Moderation: An Alternative Interpretation

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  • Efrem Castelnuovo

    (Melbourne Institute of Applied Economic and Social Research, The University of Melbourne; Department of Economics, The University of Melbourne; and Department of Economics and Management, University of Padova)

Abstract

Cholesky-VAR impulse responses estimated with post-1984 U.S. data predict modest macroeconomic reactions to monetary policy shocks. We interpret this evidence by employing an estimated medium-scale DSGE model of the business cycle as a DataGenerating Process in a Monte Carlo exercise in which a Cholesky-VAR econometrician is asked to estimate the effects of an unexpected, temporary increase in the policy rate. Our structural DSGE model predicts conventional macroeconomic reactions to a policy shock. In contrast, our Monte Carlo VAR results replicate our evidence obtained with actual U.S. data. Hence, modest macroeconomic effects may very well be an artifact of Cholesky-VARs. A combination of supply and demand shocks may be behind the inability of Cholesky-VARs to replicate the actual macroeconomic responses. The difference in the VAR responses obtained with Great Inflation vs. Great Moderation data may be due to instabilities in the parameters related to households’ and firms’ programs, more than to a more aggressive systematic monetary policy. A Monte Carlo assessment of sign restrictions as an alternative identification strategy is also proposed.

Suggested Citation

  • Efrem Castelnuovo, 2016. "Modest Macroeconomic Effects of Monetary Policy Shocks during the Great Moderation: An Alternative Interpretation," Melbourne Institute Working Paper Series wp2016n30, Melbourne Institute of Applied Economic and Social Research, The University of Melbourne.
    • Handle: RePEc:iae:iaewps:wp2016n30
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    3. Giovanni Pellegrino & Federico Ravenna & Gabriel Züllig, 2021. "The Impact of Pessimistic Expectations on the Effects of COVID‐19‐Induced Uncertainty in the Euro Area," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 83(4), pages 841-869, August.
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    5. Juho Koistinen & Bernd Funovits, 2022. "Estimation of Impulse-Response Functions with Dynamic Factor Models: A New Parametrization," Papers 2202.00310, arXiv.org, revised Feb 2022.

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    More about this item

    Keywords

    Monetary policy shocks; Cholesky identification; VARs; Dynamic Stochastic General Equilibrium models; Monte Carlo simulations;
    All these keywords.

    JEL classification:

    • C3 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables
    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles

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