Structural Factor-Augmented VAR (Sfavar) and the Effects of Monetary Policy

48 Pages Posted: 17 Apr 2005

See all articles by Francesco Belviso

Francesco Belviso

Princeton University

Fabio Milani

University of California, Irvine - Department of Economics

Date Written: March 2005

Abstract

Factor-augmented VARs (FAVARs) have combined standard VARs with factor analysis to exploit large data sets in the study of monetary policy. FAVARs enjoy a number of advantages over VARs: they allow a better identification of the monetary policy shock; they can avoid the use of a single variable to proxy theoretical constructs, such as the output gap; they allow researchers to compute impulse responses for hundreds of variables. Their shortcoming, however, is that the factors are not identified and, therefore, lack any economic interpretation.

This paper seeks to provide an interpretation to the factors. We propose a novel Structural Factor-Augmented VAR (SFAVAR) model, where the factors have a clear meaning: Real Activity factor, Price Pressures factor, Financial Market factor, Credit Conditions factor, Expectations factor, etc. The paper employs a Bayesian approach to extract the factors and jointly estimate the model. This framework is then suited to study the effects on a wide range of macroeconomic variables of monetary policy and non-policy shocks.

Keywords: VAR, Dynamic Factors, Monetary Policy, Structural FAVAR

JEL Classification: C32, C43, E50, E52, E58

Suggested Citation

Belviso, Francesco and Milani, Fabio, Structural Factor-Augmented VAR (Sfavar) and the Effects of Monetary Policy (March 2005). Available at SSRN: https://ssrn.com/abstract=695483 or http://dx.doi.org/10.2139/ssrn.695483

Francesco Belviso

Princeton University ( email )

22 Chambers Street
Princeton, NJ 08544-0708
United States

Fabio Milani (Contact Author)

University of California, Irvine - Department of Economics ( email )

3151 Social Science Plaza
Irvine, CA 92697-5100
United States

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