An Explicit Structural Model of Forward-Lookingness in Money Rules and Taylor Rules

An Explicit Structural Model of Forward-Lookingness in Money Rules and Taylor Rules

Abstract

This paper proposes a novel structural identification that assumes a policy feedback rule, like the Taylor rule, is appropriate. Then we generate a cloud of impulse responses of macro variables associated with this feedback rule. By adjusting structural parameters in the feedback rule and observing simulated impulse responses, we manage to answer the question of how model uncertainty affects estimation. In 5625 different specifications of the policy feedback rule, we find that the Wu and Xia (2016) shadow rate, as the policy indicator, gives rise to a large set of puzzling responses of the price and real output. Substituting the policy indicator with Divisia M4 or M2 incurs a far smaller incidence of puzzle responses. Our results suggest that the superiority of Divisia monetary aggregates in indicating monetary policy is not a consequence of favorable structural assumptions but an outcome of the comprehensive information content about policy actions in money.

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Zhengyang (Robin) Chen
Assistant Professor in Economics

My research interests include Macroeconomics and Monetary Economics, Time Series Analysis and Financial Economics.