The ‘price puzzle’, once more

Abstract

The VAR monetary literature has long exhibited a ‘price puzzle’: after a positive innovation on the policy interest rate, the price level tends to increase rather than to decrease. This paper shows that introducing fiscal data (primary surplus and net debt) proves fruitful in a VAR model also featuring the output gap, the inflation rate and the nominal short-term interest rate: the ‘price puzzle’ vanishes.

Notes

¹ Giordani (2004) performs structural VARs assuming a recursive identification structure. Robustness of the main results of the present paper to recursively-identified structural shocks were checked.

² A close economy model surely fits quite well a very large country like the USA.

³ Hanson (2004) investigated the inflation forecasting power of a long list of ‘candidate indicators over multiple horizons’ among which fiscal data are exclusively related to interest rates. No indicator is found to have an ability to resolve the ‘puzzle’.