Winter 2006 / Economics, U.C. Davis
Problem Set 2 – Due: February 7
1. Supose (yt, xt)’ can be represented by a pth order, reduced-form VAR. Let W be the reduced form variance-covariance matrix. You consider two identification schemes of the structural VAR: a Cholesky decomposition based on the ordering (yt, xt)’ and a Blanchard-Quah, long-run identification based on the assumption that shocks to that shocks to xt have no effect on yt in the long-run.
(a) Show whether these two different assumptions are compatible or whether they imply different structural impulse responses.
(b) Do your results translate for VARs containing more than two variables?
(c) Briefly, what is the intuition for your results.
2. The website contains the Christiano, Eichenbaum and Evans (CEE) (1992) data that was used in the Evans and Marshall (EM) (1998) paper, updated to 2001. This is collected in the EViews file labeled cee92.wf1. The series are labeled: EM for the log of non-agricultural employment; P for the log of prices; PCOM for the change in the index of sensitive materials; FF for the federal funds rate; NBRX for the ratio of nonborrowed reserves to lagged total reserves; and DM2 for M2 growth. A more careful definition of these variables is available in either paper.
(a) Estimate the appropriate VAR (i.e., formally test for the optimal lag length). Note, CEE and EM used 12 lags – why do you think this was? Hint: notice the response of P to shocks in FF as you shorten the lag length.
(b) Compute the impulse response functions to a monetary shock by identifying the structural model with your favorite identification assumptions (properly justified). Briefly comment on the results. Note CEE and EM used the ordering: EM, P, PCOM, FF, NBRX, and DM2. Verify that you are able to replicate their results.
(c) Use long-run restrictions based on nominal and monetary variables not having long-rum effects of output (be sure to impose enough to achieve exact identification). How do your results vary with respect to short-run restrictions that impose similar zero coefficient restrictions?
(d) Summarize your main findings and your views on the lessons you learned about the effects of monetary policy on the economy.
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