VAR meets DSGE : Uncovering the Monetary Transmission Mechanism in Low-Income Countries
Assesses the impact on VAR-based inference of short data samples, measurement error, high-frequency supply shocks
Abstract
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.
This work is part of the ‘Macroeconomics in Low-income countries’ programme
Citation
Bin Grace Li, Stephen A. O’Connell, Christopher S Adam, Andrew Berg, Peter J Montiel (2017) VAR meets DSGE: Uncovering the Monetary Transmission Mechanism in Low-Income Countries IMF Working Paper No. 16/90
Links
VAR meets DSGE : Uncovering the Monetary Transmission Mechanism in Low-Income Countries