IDEAS home Printed from https://ideas.repec.org/p/rba/rbardp/rdp2010-07.html
   My bibliography  Save this paper

Monetary Policy and the Exchange Rate: Evaluation of VAR Models

Author

Listed:
  • Jarkko Jääskelä

    (Reserve Bank of Australia)

  • David Jennings

    (Reserve Bank of Australia)

Abstract

This paper examines the ability of vector autoregressive (VAR) models to properly identify the transmission of monetary policy in a controlled experiment. Simulating data from an estimated small open economy DSGE model for Australia, we find that sign-restricted VAR models do reasonably well at estimating the responses of macroeconomic variables to monetary policy shocks. This is in contrast to models that use recursive zero-type restrictions, for which inflation can rise following an unexpected interest rate increase while the exchange rate can appreciate or depreciate depending on the ordering of the variables. However, central tendency measures of sign-restricted VAR models can be misleading and hardly ever coincide with the true impulses. This finding casts doubt on the common notion that the median impulses are the ‘most probable’ description of the true data generating process. Finally, the paper presents some results from a sign-restricted VAR model estimated using Australian data.

Suggested Citation

  • Jarkko Jääskelä & David Jennings, 2010. "Monetary Policy and the Exchange Rate: Evaluation of VAR Models," RBA Research Discussion Papers rdp2010-07, Reserve Bank of Australia.
    • Handle: RePEc:rba:rbardp:rdp2010-07
    as

    Download full text from publisher

    File URL: https://www.rba.gov.au/publications/rdp/2010/pdf/rdp2010-07.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Hilde C. Bjørnland & Jørn I. Halvorsen, 2014. "How does Monetary Policy Respond to Exchange Rate Movements? New International Evidence," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 76(2), pages 208-232, April.
    2. Bjørnland, Hilde C., 2009. "Monetary policy and exchange rate overshooting: Dornbusch was right after all," Journal of International Economics, Elsevier, vol. 79(1), pages 64-77, September.
    3. Carlstrom, Charles T. & Fuerst, Timothy S. & Paustian, Matthias, 2009. "Monetary policy shocks, Choleski identification, and DNK models," Journal of Monetary Economics, Elsevier, vol. 56(7), pages 1014-1021, October.
    4. Kapetanios, G. & Pagan, A. & Scott, A., 2007. "Making a match: Combining theory and evidence in policy-oriented macroeconomic modeling," Journal of Econometrics, Elsevier, vol. 136(2), pages 565-594, February.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Lance A. Fisher & Hyeon-seung Huh, 2022. "Systematic Monetary Policy in a SVAR for Australia," Working papers 2022rwp-194, Yonsei University, Yonsei Economics Research Institute.
    2. Benjamin Beckers, 2020. "Credit Spreads, Monetary Policy and the Price Puzzle," RBA Research Discussion Papers rdp2020-01, Reserve Bank of Australia.
    3. Renée Fry & Adrian Pagan, 2011. "Sign Restrictions in Structural Vector Autoregressions: A Critical Review," Journal of Economic Literature, American Economic Association, vol. 49(4), pages 938-960, December.
    4. Bazhenova Olena & Bazhenova Yuliya, 2016. "Modelling the Impact of External Shocks on Economy of Ukraine: Dsge Approach," Ekonomika (Economics), Sciendo, vol. 95(1), pages 64-83, January.
    5. Matthew Read, 2023. "Estimating the Effects of Monetary Policy in Australia Using Sign‐restricted Structural Vector Autoregressions," The Economic Record, The Economic Society of Australia, vol. 99(326), pages 329-358, September.
    6. James Bishop & Peter Tulip, 2017. "Anticipatory Monetary Policy and the 'Price Puzzle'," RBA Research Discussion Papers rdp2017-02, Reserve Bank of Australia.
    7. Jamie Murray, 2013. "Parameter Uncertainty and the Fiscal Multiplier," Treasury Working Paper Series 13/19, New Zealand Treasury.
    8. Jonathan Hambur & Qazi Haque, 2023. "Can We Use High-frequency Yield Data to Better Understand the Effects of Monetary Policy and Its Communication? Yes and No!," RBA Research Discussion Papers rdp2023-04, Reserve Bank of Australia.
    9. Fisher, Lance A. & Huh, Hyeon-seung, 2016. "Monetary policy and exchange rates: Further evidence using a new method for implementing sign restrictions," Journal of Macroeconomics, Elsevier, vol. 49(C), pages 177-191.
    10. Thanabalasingam Vinayagathasan, 2014. "Monetary policy and the real economy: A structural VAR approach for Sri Lanka," Asian Journal of Empirical Research, Asian Economic and Social Society, vol. 4(1), pages 41-64, January.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Jääskelä, Jarkko P. & Jennings, David, 2011. "Monetary policy and the exchange rate: Evaluation of VAR models," Journal of International Money and Finance, Elsevier, vol. 30(7), pages 1358-1374.
    2. K. Istrefi & B. Vonnak, 2015. "Delayed Overshooting Puzzle in Structural Vector Autoregression Models," Working papers 576, Banque de France.
    3. Alstadheim, Ragna & Bjørnland, Hilde C. & Maih, Junior, 2021. "Do central banks respond to exchange rate movements? A Markov-switching structural investigation of commodity exporters and importers," Energy Economics, Elsevier, vol. 96(C).
    4. Hilde C. Bjørnland & Jørn I. Halvorsen, 2014. "How does Monetary Policy Respond to Exchange Rate Movements? New International Evidence," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 76(2), pages 208-232, April.
    5. Philip Liu & Konstantinos Theodoridis, 2012. "DSGE Model Restrictions for Structural VAR Identification," International Journal of Central Banking, International Journal of Central Banking, vol. 8(4), pages 61-95, December.
    6. T. Philipp Dybowski & Max Hanisch & Bernd Kempa, 2018. "The role of the exchange rate in Canadian monetary policy: evidence from a TVP-BVAR model," Empirical Economics, Springer, vol. 55(2), pages 471-494, September.
    7. Guido Turnip, 2017. "Identification of Small Open Economy SVARs via Markov-Switching Heteroskedasticity," The Economic Record, The Economic Society of Australia, vol. 93(302), pages 465-483, September.
    8. Karau, Sören, 2024. "Relative monetary policy and exchange rates," Discussion Papers 40/2024, Deutsche Bundesbank.
    9. Jongrim Ha & Inhwan So, 2017. "Which Monetary Shocks Matter in Small Open Economies? Evidence from SVARs," Working Papers 2017-2, Economic Research Institute, Bank of Korea.
    10. Bjørnland, Hilde C. & Jacobsen, Dag Henning, 2010. "The role of house prices in the monetary policy transmission mechanism in small open economies," Journal of Financial Stability, Elsevier, vol. 6(4), pages 218-229, December.
    11. Beckmann, Joscha & Breitenlechner, Max & Scharler, Johann, 2024. "Is the exchange rate a shock absorber? The shocks matter," International Review of Economics & Finance, Elsevier, vol. 89(PB), pages 114-130.
    12. Fisher, Lance A. & Huh, Hyeon-seung, 2016. "Monetary policy and exchange rates: Further evidence using a new method for implementing sign restrictions," Journal of Macroeconomics, Elsevier, vol. 49(C), pages 177-191.
    13. Fisher, Lance A. & Huh, Hyeon-seung, 2019. "An IV framework for combining sign and long-run parametric restrictions in SVARs," Journal of Macroeconomics, Elsevier, vol. 61(C), pages 1-1.
    14. Xuan Vinh Vo & Phuc Canh Nguyen, 2017. "Monetary Policy Transmission in Vietnam: Evidence from a VAR Approach," Australian Economic Papers, Wiley Blackwell, vol. 56(1), pages 27-38, March.
    15. Francesco Zanetti & Christoph Görtz & Wei Li & John Tsoukalas, 2020. "Vintage Article: The Effect of Monetary Policy Shocks in the United Kingdom: an External Instruments Approach," Economics Series Working Papers 812, University of Oxford, Department of Economics.
    16. Ali, Syed Zahid & Anwar, Sajid, 2018. "Price puzzle in a small open New Keynesian model," The Quarterly Review of Economics and Finance, Elsevier, vol. 69(C), pages 29-42.
    17. Anella Munro, 2014. "Exchange rates, expected returns and risk," Reserve Bank of New Zealand Discussion Paper Series DP2014/01, Reserve Bank of New Zealand.
    18. Matteo Barigozzi & Antonio M. Conti & Matteo Luciani, 2014. "Do Euro Area Countries Respond Asymmetrically to the Common Monetary Policy?," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 76(5), pages 693-714, October.
    19. Hussain, Syed M. & Liu, Lin, 2016. "A note on the Cogley–Nason–Sims approach," Economics Letters, Elsevier, vol. 146(C), pages 77-81.
    20. Basher, Syed Abul & Haug, Alfred A. & Sadorsky, Perry, 2012. "Oil prices, exchange rates and emerging stock markets," Energy Economics, Elsevier, vol. 34(1), pages 227-240.

    More about this item

    Keywords

    vector autoregression; sign restrictions; shock identification; small open economy models;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:rba:rbardp:rdp2010-07. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Paula Drew (email available below). General contact details of provider: https://edirc.repec.org/data/rbagvau.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.