The “Price Puzzle” under Changing Monetary Policy Regimes

André Varella Mollick, Adolfo Sachsida

Department of Economics and Finance, University of Texas-Pan American (UTPA), Edinburg, USA.
IPEA, Setor Bancario Sul Quadra 1 Sala 708, Brasilia, Brazil.

DOI: 10.4236/ib.2012.44040                

Abstract

This paper examines the “price puzzle”, the rise in the price level following a contractionary monetary policy shock, using monthly US data from 1960 to 2006. Deviating from the standard practice is including commodity prices to “solve the puzzle”, our benchmark VAR contains output, prices, the federal funds rate and M1 money stock, while the augmented VAR includes the 10-year long bond yield. Splitting the sample at October of 1979, we find very contrasting patterns and rationalize them under the changing relationship between money and the funds rate across periods. First, the price puzzle is confined to the pre-Volcker period. Second, in the pre-Volcker period the funds rate respond largely to their own shocks, while the post-Volcker period witnesses a larger role for output fluctuations. Third, positive output shocks are more recently followed by price increases, federal funds hikes, and monetary contractions, very much consistent with the “Taylor rule”. Fourth, the “monetarist experiment” of late 1979-1982 reinforces our basic results: the more explicit the reliance on money supply, the less visible the price puzzle becomes.

Keywords

Federal Funds Rate; Monetary Policy Shocks; Price Puzzle; Vector Autoregressions (VARs); United States

Conflicts of Interest

The authors declare no conflicts of interest.

References

[1]	C. Sims, “Interpreting the Macroeconomic Time Series Facts: The Effects of Monetary Policy,” European Economic Review, Vol. 36, No. 5, 1992, pp. 975-1011. doi:10.1016/0014-2921(92)90041-T
[2]	T. Awokuse and J. Yang, “The Informational Role of Commodity Prices in Formulating Monetary Policy: A Reexamination,” Economics Letters, Vol. 79, No. 2, 2003, pp. 219-224. doi:10.1016/S0165-1765(02)00331-2
[3]	M. S. Hanson, “The Price Puzzle Reconsidered,” Journal of Monetary Economics, Vol. 51, No. 7, 2004, pp. 1385-1413. doi:10.1016/j.jmoneco.2003.12.006
[4]	P. Giordani, “An Alternative Explanation of the Price Puzzle,” Journal of Monetary Economics, Vol. 51, No. 6, 2004, pp. 1271-1296. doi:10.1016/j.jmoneco.2003.09.006
[5]	S. Brissimis and N. Magginas, “Forward-Looking Information in VAR Models and the Price Puzzle,” Journal of Monetary Economics, Vol. 53, No. 6, 2006, pp. 1225-1234. doi:10.1016/j.jmoneco.2005.05.014
[6]	B. Mojon, “When Did Systematic Monetary Policy Have an Effect on Inflation?” European Economic Review, Vol. 52, No. 3, 2008, pp. 487-497. doi:10.1016/j.euroecorev.2007.02.007
[7]	D. Krusec, “The ‘Price Puzzle’ in the Monetary Transmission VARs with Long-Run Restrictions,” Economics Letters, Vol. 106, No. 3, 2010, pp. 147-150. doi:10.1016/j.econlet.2009.04.027
[8]	E. Leeper and J. Roush, “Putting ‘M’ Back in Monetary Policy,” Journal of Money, Credit, and Banking, Vol. 35, No. 6, 2003, pp. 1217-1256. doi:10.1353/mcb.2004.0031
[9]	H. Berument and R. Froyen, “Monetary Policy and Long-Term US Interest Rates,” Journal of Macroeconomics, Vol. 28, No. 4, 2006, pp. 737-751. doi:10.1016/j.jmacro.2005.02.004
[10]	B. Bernanke and A. Blinder, “The Federal Funds Rate and the Channels of Monetary Transmission,” American Economic Review, Vol. 82, No. 4, 1992, pp. 901-921.
[11]	L. Christiano, M. Eichenbaum and C. Evans, “The Effects of Monetary Policy Shocks: Evidence from the Flow of Funds,” Review of Economics and Statistics, Vol. 78, No. 1, 1996, pp. 16-34. doi:10.2307/2109845
[12]	R. Clarida, J. Gali and M. Gertler, “Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory,” Quarterly Journal of Economics, Vol. 115, No. 1, 2000, pp. 147-180. doi:10.1162/003355300554692
[13]	M. Goodfriend and R. King, “The Incredible Volcker Disinflation,” Journal of Monetary Economics, Vol. 52, No. 5, 2005, pp. 981-1015. doi:10.1016/j.jmoneco.2005.07.001