Changes in the Transmission of Monetary Policy: Evidence from a Time-Varying Factor-Augmented VAR

This paper re-examines the evolution in the US monetary transmission mechanism using an empirical framework that incorporates substantially more information than the standard trivariate VAR model used in most previous studies. In particular, we employ an extended version of the factor-augmented VAR proposed by Bernanke et al. (2005). Our extensions include allowing for time variation in the coe¢ cients and stochastic volatility in the variances of the shocks. Our formulation has two clear advantages over earlier work: (i) We identify the monetary policy shock using a model that includes around 600 macroeconomic and …nancial variables, hence making it less likely that our model su¤ers from the shortcomings of small-scale models, (ii) our model allows us to estimate time-varying impulse responses for each of the variables contained in our panel. Therefore, we are able to provide results for the variation in the responses of a wide variety of variables to a monetary policy shock. In particular, this paper not only provides evidence about changes in the dynamics of main macroeconomic aggregates, but also of components of the consumption de‡ator and disaggregated consumption quantities. JEL codes: E30, E32 Keywords: FAVAR, time-varying parameters, monetary transmission This paper has bene…tted from helpful comments by Özer Karagedikli, Thomas Laubach, Gert Peersman, Robert Tetlow and participants at the CEF 2009 conference and the Bundesbank seminar. The paper is best viewed in colour. The views expressed in this work are those of the authors, and do not necessarily re‡ect those of the Bank of England or the Monetary Policy Committee. E-mail: [email protected], [email protected], [email protected].