Factor-Augmented Vector Autoregression with narrative identification. An application to monetary policy in the US

We extend the Bayesian Factor-Augmented Vector Autoregressive model (FAVAR) to incorporate an identification scheme based on external instrument approach. Using this novel modelling framework, we show that a monetary policy tightening in United States has contractionary effects economy. Moreover, accounting for large information set seems help mitigate price and real economic puzzles estimated impulse responses.