A global-local prior for time-varying parameter VARs and monetary policy
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Date
2020
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Abstract
Time-varying parameter VARs have become the workhorse models in empirical
macroeconomics. These models are usually equipped with tightly
parametrized prior distributions which favor a small and gradual change in
parameters. Do such prior distributions suppress some degree of time variation
in the VAR coefficients? We address this question by proposing a
exible global-local prior. It turns out that the conventional prior may suppress economically
relevant patterns of time variation. Using the global-local prior,
we observe that parameter change can be abrupt rather than smooth. We
find that, during the chairmanship of Paul Volcker, the Fed has been fighting
inflation pressures by raising the interest rate in response to a negative supply
shock. However, during the chairmanship of Alan Greenspan, this policy
came to an end. In contrast, using the conventional prior, we do not detect
this pattern.
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Keywords
TVP-VAR, monetary policy, global-local prior