MONETARY POLICY TRANSMISSION MECHANISM AND DYNAMIC FACTOR MODELS

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By: Andreea RO┼×OIU
JEL: E31, C15, C58, E52,, C82
Keywords: Factor Augmented Vector Autoregression, Monetary Policy Transmission Mechanism, Romanian Economy, Time Varying Parameters

The main objective of a Central Bank is price stability, without neglecting, however, a sustainable economic growth in the long run. Therefore, an important challenge is to identify whether the effect of monetary policy has changed over time and for this purpose, a Dynamic Factor Model with time-varying parameters is estimated. The model is applied to Romanian economy, on a sample database consisting of 90 time series representing various macroeconomic variables. Monthly data, starting with 2000 and ending with 2013 are being used for the analysis. The reason for using a large dataset is to avoid issues such as omitting important information when considering a small set of variables. A much smaller number of Factors is extracted by using Principal Component Analysis and with these factors the TVP-FAVAR model is estimated. Time variation of the parameters allows for o comparative analysis of the monetary policy transmission mechanism in time. Once the impulse-response functions are estimated, several conclusions are to be drawn, such as: whether monetary policy actions have or do not have an impact over the evolution of the rest of the economy and whether the effect of these measures have changed over the years.