Author: Dawit Legesse Senbet

Publisher:

Published: 2007

Total Pages: 362

ISBN-13:

This dissertation employs factor-augmented vector autoregressive (FAVAR) models to investigate the impact, transmission mechanism and reaction function of monetary policy. The recent development of augmenting dynamic factor analysis with the vector autoregressive (VAR) models, pioneered by Bernanke et al. (2005), has led to advances in monetary policy analysis. The new approach bases measurements of monetary policy on large data sets that approximate the true information set of policymakers. This is in contrast to low dimensional VAR models. The FAVAR model summarizes information from large data set by a few factors that are incorporated into VAR models. The first essay investigates the impact of monetary policy on a wide range of macroeconomic indicators for the United States, Canada, the U.K., Japan and France using FAVAR models. I also examine the influence of United States' monetary policy on the other countries in the sample. This essay incorporates between 70 and 80 monthly macro variables for each country. The results show that, first, the FAVAR model eliminates the "price puzzle" response for all countries. Second, monetary policy has plausible impacts on a wide range of economic variables. Third, there is evidence of United States' monetary policy influence on Canada, the U.K. and Japan. In the second essay, I investigate the channels of monetary policy transmission in the United States using the FAVAR models. This essay builds on the debates on whether monetary policy works through the credit channel, in addition to the traditional interest rate channel. I include 154 United States' monthly macro variables. The findings support the existence of the credit channel in the United States. The third essay builds on the seminal work of Taylor (1993) to study the reaction functions of monetary policymakers in the United States, Canada, the U.K. and Japan. I include monthly data on 80 to 150 macro variables in the FAVAR model to investigate the policy reaction functions. The findings show that monetary policymakers react to many variables including capacity utilization rates, unemployment rates, monetary aggregates, exchange rates, and long-term interest rates in addition to the inflation and the output gaps.