Editor’s note: This post is part of a series showcasing Barcelona GSE master projects by students in the Class of 2015. The project is a required component of every master program.
Adrian Ifrim and Önundur Páll Ragnarsson
Macroeconomic Policy and Financial Markets
We propose a new identification method in open economy models by restricting both the systematic component of monetary policy and the IRFs to a monetary policy shock, at the same time remaining agnostic with respect to the effects of monetary policy shocks on output and open economy variables. We estimate the model for the U.S/U.K economies and find that a U.S monetary shock has a significant and permanent effect on output. Quantitatively a 0.4% annual increase in the interest rates causes output to contract by 1.2%. This contradicts the findings of Uhlig (2005) and Scholl and Uhlig (2008). We compute the long-run multipliers implied by the monetary policy reaction function and compare our identification with to the ones proposed by Uhlig (2005), Scholl and Uhlig (2008) and Arias et al. (2015). We argue that neither of the above schemes identify correctly the monetary policy shock since the latter overestimates the effects of the shock and the former implies a counterfactual behavior of monetary policy. We also find that the delayed overshooting puzzle is a robust feature of the data no matter what identification is chosen.
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