STRATHCLYDE DISCUSSION PAPERS IN ECONOMICS ASSESSING THE TRANSMISSION OF MONETARY POLICYSHOCKS USING DYNAMIC FACTOR MODELS BY

The evolution of monetary policy in the U.S. is examined based on structural dynamic factor models. I extend the current literature which questions the stability of the monetary transmission mechanism, by proposing and studying time-varying parameters factor-augmented vector autoregressions (TVP-FAVAR), which allow for fast and effi-cient inference based on hundreds of explanatory variables. Different specifications are compared where the factor loadings, VAR coeffi-cients and error covariances, or combinations of those, may change gradually in every period or be subject to small breaks. The model is applied to 157 post-World War II U.S. quarterly macroeconomic vari-ables. The results clearly suggest that the propagation of the mone-tary and non-monetary (exogenous) shocks has altered its behavior, and specifically in a fashion which supports smooth evolution rather than abrupt change. The most notable changes were in the responses of real activity measures, prices and monetary aggregates, while other key indicators of the economy remained relatively unaffected