VAR meets DSGE: Uncovering the Monetary Transmission Mechanism in Low-Income Countries

By Grace B Li, Stephen A. O'Connell, Christopher S Adam, Andrew Berg, Peter J Montiel

April 11, 2016

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Grace B Li, Stephen A. O'Connell, Christopher S Adam, Andrew Berg, and Peter J Montiel. VAR meets DSGE: Uncovering the Monetary Transmission Mechanism in Low-Income Countries, (USA: International Monetary Fund, 2016) accessed November 21, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

VAR methods suggest that the monetary transmission mechanism may be weak and unreliable in low-income countries (LICs). But are structural VARs identified via short-run restrictions capable of detecting a transmission mechanism when one exists, under research conditions typical of these countries? Using small DSGEs as data-generating processes, we assess the impact on VAR-based inference of short data samples, measurement error, high-frequency supply shocks, and other features of the LIC environment. The impact of these features on finite-sample bias appears to be relatively modest when identification is valid—a strong caveat, especially in LICs. However, many of these features undermine the precision of estimated impulse responses to monetary policy shocks, and cumulatively they suggest that “insignificant” results can be expected even when the underlying transmission mechanism is strong.

Subject: Dynamic stochastic general equilibrium models, Econometric analysis, Economic theory, Environment, Structural vector autoregression, Supply shocks, Vector autoregression

Keywords: Africa, Dynamic stochastic general equilibrium models, Estimation environment, Exchange-rate elasticity, Features of the estimation environment, GDP gap, Inflation rate, Interest rate, Interest rate target, LIC context, LIC environment, Low Income Countries, Monetary policy, Monetary policy effect, Monetary policy rule, Monetary policy shock, Monetary Transmission Mechanism, Monte Carlo Methods, Research environment, Structural vector autoregression, Supply shocks, Transmission mechanism, Vector autoregression, Vector Autoregression Methods, WP

Publication Details

Pages:

45
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2016/090
Stock No:

WPIEA2016090
ISBN:

9781484324752
ISSN:

1018-5941

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