This paper investigates the effects of monetary policy in the US by comparing a system of equations – estimated from a VECM (vector error correction model) – to a SVAR (structural autoregressive) model. Vector error-correction models are used when there exists long-run equilibrium relation-ships between non-stationary data integrated of the same order.
Those models imply that the stationary transformations of the variables adapt to disequilibria between the non-stationary variables in the model. In contrast, SVAR models focus on the contemporaneous interdependence between the variables. The authors apply these two methods on a model with a contractionary monetary policy which affects the short-term interest rate. Following Sims and Zha the authors use a shock to the Treasury Bill rate instead of a shock to the Federal Funds rate.
The paper continues as follows. First, a description of the data is given. Secondly, it presents a system of equations built from the LSE approach, aiming at macroeconomic simulations. Thirdly, it compares results obtained from the previous part to those obtained using SVAR impulse response functions (IRFs) identified with sign restrictions. The paper focuses on the impact of the simulated policies or monetary shocks on GDP and its growth rate.
Table of Contents
1 Introduction
2 Data
3 The LSE approach
3.1 Vector error correction model
3.2 Simulations
3.3 Coefficients instability
4 Structural VAR
4.1 Sign restrictions
4.2 Impulse response functions
5 Conclusion
Research Objectives and Core Themes
This study aims to evaluate the impact of monetary policy on the U.S. economy, specifically focusing on its effects on Gross Domestic Product (GDP), by comparing two distinct econometric methodologies: a Vector Error Correction Model (VECM) and a Structural Vector Autoregression (SVAR) model.
- Comparison of VECM and SVAR methodologies in evaluating monetary policy.
- Use of the three-month Treasury Bill rate as a proxy for the Federal Funds rate.
- Investigation of long-run equilibrium relationships through the LSE approach.
- Application of sign restrictions for structural identification in SVAR models.
- Analysis of the impact of monetary policy shocks on output growth and macroeconomic variables.
Excerpt from the Book
3 The LSE approach
For the creation of a system of equations, the LSE approach is used instead of the Cowles Commission (CC) approach. The CC methodology assumes that the structural form of the data generating process (DGP) is known qualitatively and the reduced form is then derived from it. The LSE approach explains the failure of the CC approach; there is a lack of attention for the statistical model underlying the econometric structure adopted. The LSE approach recognises that economic theory suggests the general specification of the relevant form but the precise DGP is almost never known. The reduced form takes a central role within this approach in that it represents the crucial probabilistic structure of the data. The approach is thus turned backwards, the reduced form will lead to the structural one.
Summary of Chapters
1 Introduction: This chapter outlines the research motivation regarding the effects of monetary policy and presents the paper's dual-methodology structure using VECM and SVAR.
2 Data: This section details the monthly time series data collected from the FRED database covering the period from 1959 to 2017.
3 The LSE approach: This chapter discusses the LSE-based system of equations, addressing cointegration, model simulations, and the issue of coefficient instability over time.
4 Structural VAR: This section evaluates monetary policy through an SVAR model, employing sign restrictions and impulse response functions to identify shocks.
5 Conclusion: This final chapter synthesizes the findings from both approaches, noting the limited impact of interest rate changes on long-term GDP levels.
Keywords
Monetary Policy, US Economy, VECM, SVAR, GDP, Treasury Bill, Sign Restrictions, Impulse Response Functions, Cointegration, Macroeconomics, Interest Rate, Economic Modeling, Statistical Analysis, Structural Breaks, Time Series.
Frequently Asked Questions
What is the primary objective of this research paper?
The paper seeks to evaluate the causal effects of monetary policy on the US economy, specifically its impact on GDP, by employing two different econometric frameworks.
What are the central thematic areas covered in this work?
The work focuses on macroeconomic time series analysis, specifically investigating how different monetary policy shocks—simulated via interest rate adjustments—affect economic output.
Which methodology is used to conduct the economic analysis?
The authors employ two primary methods: a Vector Error Correction Model (VECM) based on the LSE approach for long-run equilibrium and a Structural VAR (SVAR) model using sign restrictions for short-run shock identification.
What does the main body of the paper treat?
The main body treats the identification of cointegrating relationships (VECM), the simulation of interest rate scenarios, the implementation of sign restrictions to handle identification puzzles, and the resulting impulse response functions.
Which proxy is used for the Federal Funds rate?
Following established academic precedent, the authors use the three-month Treasury Bill rate as a proxy for the Federal Funds rate.
What is the significance of the "price puzzle" mentioned in the text?
The "price puzzle" is a phenomenon where contractionary monetary policy appears to cause a short-run increase in inflation; the authors use specific modeling techniques to mitigate this anomaly.
How does the VECM approach differ from the SVAR approach?
The VECM approach focuses on capturing long-run equilibrium relationships between non-stationary variables, whereas the SVAR approach emphasizes contemporaneous interdependence between stationary transformations of those variables.
What was the outcome regarding the impact of monetary policy on GDP?
The study concludes that while high interest rates tend to decrease GDP and its growth rate in the short run, the overall effects on the long-term level of output appear to be relatively small.
- Arbeit zitieren
- Colin Tissen (Autor:in), E Voisin (Autor:in), 2017, The Effects of Monetary Policy in the US. The Vector Error Correction Model (VECM) compared to the Structural Autoregressive Model (SVAR), München, GRIN Verlag, https://www.grin.com/document/377268
