Working Paper

Using measures of expectations to identify the effects of a monetary policy shock

Abstract: This paper considers an alternative econometric approach to the VAR methodology for identifying and estimating the effects of monetary policy shocks. The alternative approach incorporates available measures of market participants' expectations of economic variables in order to calculate economic innovations to those variables. In general, expectations measures should provide important additional information relative to a standard VAR analysis, since market participants presumably use a much richer information set than that assumed in a typical VAR model. The resulting innovations are easily incorporated in a VAR-like framework. ; The empirical results are quite surprising. First, when expectations are incorporated, the variance of all innovations is reduced substantially. Second, innovations to the federal funds rate derived using the alternative approach are only somewhat correlated with their VAR counterparts, while innovations to other economic variables are essentially uncorrelated. Still, monetary policy shocks derived using both approaches are still somewhat correlated, however, since innovations to prices and economic activity explain only a small fraction of innovations to the federal funds rate. As a consequence, the impulse responses of economic variables to the two sets of monetary policy shocks have remarkably similar properties.

Keywords: Monetary policy;

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: International Finance Discussion Papers

Publication Date: 1996

Number: 537