Real and Nominal Effects of Monetary Policy Shocks

by Bhuiyan, Mohammad Rokonuzzaman

Abstract (Summary)
Using Canadian data we estimate the effects of monetary policy shocks on various real and nominal variables using a fully recursive VAR model. We decompose the nominal interest rate into an ex-ante real interest rate and inflationary expectations using the Blanchard-Quah structural VAR model with the identifying restriction that ex-ante real interest rate shocks have but a temporary impact on the nominal interest rate. The inflationary expectations are then employed to estimate a policy reaction function that identifies monetary policy shocks. We find that a positive shock introduced by raising the monetary aggregates raises inflationary expectations and temporarily lowers the ex-ante real interest rate. As well, it depreciates the Canadian dollar and generates other macro effects consistent with conventional monetary theory although these effects are not statistically significant. Using the overnight target rate as the monetary policy instrument we find that a contractionary monetary policy shock lowers inflationary expectations and raises the ex-ante real interest. Such a contractionary monetary policy shock also appreciates the Canadian currency, decreases industrial output and increases the unemployment rate. We obtain qualitatively better results using the overnight target rate rather than a monetary aggregate as the monetary policy instrument. Our estimated results are robust to various modifications of the basic VAR model and do not encounter empirical anomalies such as the liquidity and exchange rate puzzles found in some previous VAR studies of the effects of monetary policy shocks in an open economy.
Bibliographical Information:

Advisor:Cushman, David O.; Lucas, Robert F.; Racine, Marie; Tran, Kien C.

School:University of Saskatchewan

School Location:Canada - Saskatchewan

Source Type:Master's Thesis

Keywords:inflationary expectations ex ante monetary policy


Date of Publication:08/20/2004

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