Price puzzle
The price puzzle is a phenomenon in monetary economics observed within structural vector autoregression (SVAR) models. It refers to the counterintuitive result where a contractionary monetary policy shock—typically modeled as an increase in short-term interest rates—is followed by an increase, rather than a decrease, in the price level. This anomaly challenges conventional macroeconomic theories that predict a decline in prices as monetary tightening reduces aggregate demand.
Historical Context
[edit]The term "price puzzle" was first introduced by Lawrence Christiano in 1992,[1] who observed this anomaly in SVAR models analyzing U.S. monetary policy. Early studies found that when using short-term interest rates, such as the federal funds rate, as the primary indicator of monetary policy, SVAR models often produced results inconsistent with theoretical expectations. This sparked a series of investigations into the limitations of these models and the underlying causes of the puzzle.
Efforts to Resolve the Price Puzzle
[edit]Augmented Information Sets
[edit]One approach to resolving the price puzzle involves expanding the information set in SVAR models. For instance, including variables like commodity prices or Federal Reserve forecasts (e.g., Greenbook data) can provide additional context for policy decisions, reducing the puzzle's prevalence.[2][3]
Divisia Monetary Aggregates
[edit]The study of Divisia monetary aggregates as superior policy indicators has its roots in the work of Keating et al.[4] and Belongia and Ireland,[5] who emphasized the importance of incorporating broad monetary aggregates into economic models to better understand monetary policy effects. Their research demonstrated that Divisia aggregates outperform traditional simple-sum measures, such as M1 and M2, by resolving anomalies like the price puzzle and establishing a more stable relationship between money supply and macroeconomic variables.
References
[edit]- ^ Christiano, Lawrence J. (1992). "Investigations of monetary policy rules". Carnegie-Rochester Conference Series on Public Policy. 41: 151–195. doi:10.1016/0167-2231(94)90010-8. ISSN 0167-2231.
- ^ Christiano, Lawrence J.; Eichenbaum, Martin; Evans, Charles L. (1999). "Monetary policy shocks: What have we learned and to what end?". Handbook of Macroeconomics. 1: 65–148. doi:10.1016/S1574-0048(99)01005-8. ISSN 1574-0048.
- ^ Romer, Christina D.; Romer, David H. (2004). "A new measure of monetary shocks: Derivation and implications". American Economic Review. 94 (4): 1055–1084. doi:10.1257/0002828042002651. ISSN 0002-8282.
- ^ Keating, John W.; Kelly, L.J.; Smith, A.L.; Valcarcel, Victor J. (February 2019). "A model of monetary policy shocks for financial crises and normal conditions". Journal of Money, Credit and Banking. 51 (1): 227–259. doi:10.1111/jmcb.12510.
- ^ Belongia, Michael T.; Ireland, Peter N. (2014). "The Barnett critique after three decades: A new Keynesian analysis". Journal of Econometrics. 183 (1): 5–21. doi:10.1016/j.jeconom.2014.06.008. hdl:10419/101887. ISSN 0304-4076.