The dynamic effects of monetary policy: A structural factor model approach

We use the structural factor model proposed by Forni, Giannone, Lippi and Reichlin (2007) to study the effects of monetary policy. The advantage with respect to the traditional vector autoregression model is that we can exploit information from a large data set, made up of 112 US monthly macroeconomic series. Monetary policy shocks are identified using a standard recursive scheme, in which the impact effects on both industrial production and prices are zero. Such a scheme, when applied to a VAR including a suitable selection of our variables, produces puzzling results. Our main findings are the following. (i) The maximal effect on bilateral real exchange rates is observed on impact, so that the “delayed overshooting” or “forward discount” puzzle disappears. (ii) After a contractionary shock prices fall at all horizons, so that the price puzzle is not there. (iii) Monetary policy has a sizable effect on both real and nominal variables. Such results suggest that the structural factor model is a promising tool for applied macroeconomics