Abstract
We propose a novel approach that directly embeds rational expectations (RE) into a low-dimensional structural vector autoregression (SVAR) without the need for any mapping to a dynamic stochastic general equilibrium (DSGE) model. Beginning from a fully specified “consensus” structural model, we establish an instrumental variable procedure internal to the SVAR to obtain RE-consistent structural responses to identified monetary policy shocks. Our RE-SVAR framework facilitates a comparison across two alternative monetary policy indicators that accommodate long horizons in the formation of inflation expectations in the policy rule. We construct clouds of responses of inflation and economic activity to monetary policy shocks. We find large regions of puzzling responses to innovations in the federal funds rate. This suggests that indicator often requires being augmented with more information in standard VAR settings. A money growth rule characterization—with Divisia M4 as a policy indicator—exhibits comparatively larger regions of sensible responses within a low-dimensional textbook model of the economy.
Modeling Inflation Expectations in Forward-Looking Interest Rate and Money Growth Rules
Summary
This paper by Zhengyang Chen (University of Northern Iowa) and Victor J. Valcarcel (University of Texas at Dallas) introduces a new method for analyzing monetary policy that directly incorporates rational expectations into economic models. Published in the Journal of Economic Dynamics and Control (2025), the work addresses a longstanding puzzle in monetary economics known as the “price puzzle.”
The Problem: The Price Puzzle
Traditional economic models used to study monetary policy often suffer from what economists call the price puzzle - a counterintuitive finding where prices actually increase when central banks raise interest rates, rather than decrease as economic theory predicts first coined by Eichenbaum (1992). This anomaly has plagued Structural Vector Autoregressions (SVARs) - statistical models economists use to understand how different economic variables interact over time.
The price puzzle became particularly problematic after the 2007-2008 financial crisis, when traditional interest rate policies became less effective as rates approached zero. This led economists to reconsider alternative monetary policy tools, including money supply growth rules rather than interest rate rules. The foundational work on interest rate rules includes studies by Bernanke and Blinder (1992), Gertler and Gilchrist (1994), Eichenbaum and Evans (1995), Bernanke and Mihov (1998), and Christiano et al. (1999).
The Innovation: Rational Expectations-Augmented SVAR (RE-SVAR)
The authors develop a novel RE-SVAR framework that directly embeds rational expectations - the idea that people form expectations about the future based on all available information - into a low-dimensional economic model. This builds on the revolutionary work of Lucas (1972) on rational expectations in macroeconomic modeling. Unlike previous approaches that either:
Add many variables to capture more information, as in Bernanke et al. (2005) called factor-augmented VARs (FAVARs), or
Map complex theoretical models to simpler statistical ones (see Fernández-Villaverde et al. (2007), Ravenna (2007), Morris (2016), and Martínez-García (2020))
This method starts with a fully specified theoretical model and uses an instrumental variable procedure to obtain responses consistent with rational expectations.
Key Methodology
The researchers compare two monetary policy approaches:
Interest Rate Rules: Traditional Federal Reserve policy using the federal funds rate (supplemented with the Wu and Xia (2016) shadow rate during the zero lower bound period)
Money Growth Rules: Using Divisia M4, a sophisticated measure of money supply that accounts for different types of monetary assets, following the theoretical framework of Belongia and Ireland (2014)
They generate “clouds” of responses by testing 241,865 different parameter combinations, searching for specifications that produce economically sensible results - where expansionary monetary policy leads to higher output and inflation, not lower.
Main Findings
The results strongly favor money growth rules over interest rate rules:
Interest Rate Specifications: Produced puzzling responses in 98.68% of output cases and 99.13% of inflation cases
Money Growth Specifications: Only 4.02% output puzzles and 4.13% inflation puzzles
This dramatic difference suggests that money growth indicators capture monetary policy effects much better in low-dimensional models, even when allowing for various horizons of inflation and output expectations in the policy rules. These findings are consistent with Chen and Valcarcel (2021) who reach a similar conclusion with a vastly different methodological approach.
Robustness and Extensions
The authors test their findings across:
Different time periods (1988-2020, 1967-2020, 2008-2020)
Alternative inflation measures (CPI vs. PCE)
Different monetary aggregates (Divisia M4 vs. M2)
The superiority of money growth rules remains consistent across these specifications. They also extend their framework to a four-variable system including the Gilchrist and Zakrajšek (2012) excess bond premium (EBP) measure, demonstrating that their approach can incorporate additional variables when supported by economic theory.
Theoretical Foundation
The consensus New Keynesian model underlying their analysis draws from the sticky price framework described by Keating et al. (2019), which includes:
A household Euler equation with external habit formation
A money demand equation incorporating substitution effects among monetary assets (following Belongia and Ireland, 2014)
A Phillips curve with backward price indexation (Christiano et al., 2005)
This theoretical structure allows for forward-looking behavior in both the Phillips curve and IS equation, consistent with modern macroeconomic theory.
Implications and Significance
This research contributes to several important debates in monetary economics:
Methodological Innovation: Provides a new way to incorporate forward-looking behavior in empirical models without sacrificing theoretical coherence, addressing limitations noted by Batini and Haldane (1999)
Policy Relevance: Suggests that monetary aggregates may be more informative for understanding monetary policy than previously thought, particularly important given the unconventional policies since 2008 that included the creation of new liquidity facilities and large-scale asset purchases, which swelled bank reserves
Theoretical Integration: Bridges the gap between theory-based Dynamic Stochastic General Equilibrium (DSGE) models and data-driven VAR approaches
Relationship to Prior Literature
The paper builds on several important methodological precedents:
Structural identification: Following Keating (1992) for monetary policy and Blanchard and Perotti (2002) for fiscal policy, the authors use economic theory to discipline VAR identification rather than relying purely on statistical restrictions.
Monetary aggregation theory: The work extends the foundational research of Barnett (1980) and Diewert (1976) on index number theory applied to monetary assets, providing a theoretical basis for using Divisia monetary aggregates instead of simple-sum measures.
Price puzzle solutions: The paper contributes to the ongoing literature on resolving puzzling VAR responses, building on the seminal work of Christiano et al. (1999) and the comprehensive survey by Ramey (2016) documenting the persistence of these anomalies across different specifications and time periods.
Limitations and Trade-offs
The authors acknowledge important limitations:
Non-modularity: Unlike standard VARs where variables can be easily added, their approach requires a fully specified structural equation for each additional variable incorporated into the system
Model dependence: The validity depends entirely on the appropriateness of the underlying theoretical construct
Computational intensity: Generating hundreds of thousands of model specifications is computationally expensive
Conclusion
The paper provides compelling evidence that properly specified money growth rules may offer superior guidance for monetary policy, particularly during periods when interest rates are constrained. The methodology offers a promising avenue for incorporating rational expectations into empirical monetary policy analysis while maintaining the parsimony of low-dimensional theoretical models.
This work significantly advances the recent reconsideration of money growth rules initiated by Belongia and Ireland (2022) and provides empirical support for the theoretical arguments about the information content of monetary aggregates in modern economies. The findings have important implications for central bank policy, especially as policymakers continue to grapple with the aftermath of unconventional monetary policies implemented since the Great Financial Crisis.
References
Key citations from the paper include:
Barnett, W.A. (1980). Economic monetary aggregates: an application of index number and aggregation theory. Journal of Econometrics, 14, 11–48.
Belongia, M.T., & Ireland, P.N. (2022). A reconsideration of money growth rules. Journal of Economic Dynamics and Control, 135, 104312.
Bernanke, B.S., Boivin, J., & Eliasz, P. (2005). Measuring the effects of monetary policy: a factor-augmented vector autoregressive (FAVAR) approach. Quarterly Journal of Economics, 120, 387–422.
Christiano, L.J., Eichenbaum, M., & Evans, C.L. (1999). Monetary policy shocks: What have we learned and to what end? Handbook of Macroeconomics, 1, 65–148.
Eichenbaum, M. (1992). Comment on interpreting the macroeconomic time series facts: the effects of monetary policy. European Economic Review, 36, 1001–1011.
Keating, J.W., Kelly, L.J., Smith, A.L., & Valcarcel, V.J. (2019). A model of monetary policy shocks for financial crises and normal conditions. Journal of Money, Credit and Banking, 51, 227–259.
Lucas, R.E. (1972). Expectations and the neutrality of money. Journal of Economic Theory, 4, 103–124.
Wu, J.C., & Xia, F.D. (2016). Measuring the macroeconomic impact of monetary policy at the zero lower bound. Journal of Money, Credit and Banking, 48, 253–291.
Chen, Zhengyang, and Victor J. Valcarcel. “Modeling inflation expectations in forward-looking interest rate and money growth rules.” Journal of Economic Dynamics and Control 170 (January 2025): 104999. https://doi.org/10.1016/j.jedc.2024.104999.
📚 Academic Citations & Literature Review
Papers and Topics That Could Cite Chen & Valcarcel (2025)
Chen, Zhengyang, and Victor J. Valcarcel. “Modeling inflation expectations in forward-looking interest rate and money growth rules.” Journal of Economic Dynamics and Control 170 (January 2025): 104999. https://doi.org/10.1016/j.jedc.2024.104999.
This methodological and empirical contribution could be cited across multiple research areas. Here’s a comprehensive breakdown:
1. Monetary Policy and Central Banking
Monetary Policy Rules and Frameworks
Papers comparing Taylor rules vs. alternative policy frameworks
Studies on optimal monetary policy design in different economic environments
Research on central bank communication and forward guidance effectiveness
Analysis of unconventional monetary policy tools (QE, negative rates, yield curve control)
Money Supply and Monetary Aggregates
Studies validating or challenging the role of money in monetary policy
Research on optimal monetary aggregate construction (Divisia vs. simple-sum)
Papers examining money demand stability across different periods
Studies on the information content of various monetary indicators
Zero Lower Bound and Crisis Policies
Research on monetary policy effectiveness during financial crises
Studies comparing policy tools when interest rates are constrained
Analysis of shadow rate models and their empirical applications
Papers on the transmission mechanism during extraordinary periods
2. Econometric Methodology
VAR and SVAR Methodology
Studies developing new identification strategies for structural VARs
Research addressing identification problems in macroeconomic VARs
Papers proposing alternative approaches to recursive identification
Studies on the integration of theory and empirics in VAR analysis
Rational Expectations in Empirical Models
Research incorporating forward-looking behavior in time series models
Studies bridging DSGE and VAR methodologies
Papers on expectation formation and survey data integration
Analysis of expectation channels in monetary transmission
Model Uncertainty and Robustness
Studies using set identification or multiple model approaches
Research on parameter uncertainty in policy analysis
Papers examining model averaging in macroeconomic forecasting
Studies on the robustness of empirical findings across specifications
3. Macroeconomic Theory and Modeling
New Keynesian Models
DSGE studies incorporating monetary aggregates or alternative policy rules
Research on micro-foundations of money demand in NK models
Papers examining the role of financial frictions in monetary transmission
Studies on optimal policy in models with multiple instruments
Phillips Curve and Inflation Dynamics
Research on inflation expectations formation and measurement
Studies examining the relationship between monetary policy and inflation persistence
Papers on the role of forward-looking vs. backward-looking behavior
Analysis of inflation dynamics during different monetary regimes
Financial Conditions and Monetary Transmission
Studies incorporating financial variables in monetary policy analysis
Research on the bank lending channel and monetary transmission
Papers examining the role of credit spreads in policy assessment
Analysis of unconventional policy effects on financial markets
4. Applied Macroeconometrics
Policy Evaluation Studies
Research assessing the effectiveness of different central bank policies
Studies comparing monetary policy across countries or time periods
Papers examining the real effects of monetary policy shocks
Analysis of policy trade-offs and optimal instrument choice
Forecasting and Real-Time Analysis
Studies using monetary aggregates for macroeconomic forecasting
Research on real-time policy analysis and decision-making
Papers comparing forecasting performance across different indicators
Studies on nowcasting using financial and monetary variables
Historical and Comparative Analysis
Research on monetary policy evolution across different eras
Studies comparing policy effectiveness before and after major reforms
Papers examining lessons from historical monetary experiments
Analysis of policy performance across different economic structures
5. International Macroeconomics
Cross-Country Policy Comparisons
Studies comparing monetary policy frameworks across central banks
Research on policy spillovers and international transmission
Papers examining optimal policy in open economy settings
Analysis of exchange rate effects on monetary policy effectiveness
Emerging Market Monetary Policy
Research on monetary policy in developing economies
Studies on the choice of policy instruments in different institutional settings
Papers examining the role of capital flows in monetary policy design
Analysis of dollarization and monetary sovereignty
6. Financial Economics
Asset Pricing and Monetary Policy
Studies on the effect of monetary policy on asset prices and risk premia
Research incorporating monetary policy uncertainty in asset pricing models
Papers examining the portfolio effects of different policy instruments
Analysis of the risk-taking channel of monetary policy
Banking and Financial Intermediation
Research on how different policy tools affect bank behavior
Studies on the bank lending channel with alternative policy indicators
Papers examining the role of reserves and money markets
Analysis of regulatory effects on monetary transmission
7. Behavioral and Experimental Economics
Expectation Formation
Studies on how agents form expectations about monetary policy
Research comparing rational vs. adaptive expectations in policy models
Papers using experimental methods to test expectation theories
Analysis of central bank communication effects on expectation formation
8. Policy and Regulatory Analysis
Central Bank Design and Governance
Studies on optimal central bank mandates and instrument choice
Research on central bank independence and policy effectiveness
Papers examining the political economy of monetary policy
Analysis of central bank accountability and transparency
Financial Stability and Macroprudential Policy
Research on the interaction between monetary and macroprudential policies
Studies examining the financial stability implications of different policy tools
Papers on the role of monetary policy in preventing financial crises
Analysis of policy coordination across different regulatory domains
9. Computational and Methodological Extensions
Machine Learning in Macroeconomics
Studies applying ML techniques to monetary policy analysis
Research using AI methods for policy rule optimization
Papers on big data approaches to monetary policy assessment
Analysis of text-based measures of monetary policy
High-Frequency Data Analysis
Research using high-frequency financial data to assess policy effects
Studies on the immediate market response to policy announcements
Papers examining intraday effects of monetary policy communications
Analysis of the information content of market-based measures
10. Specific Extension Opportunities
Direct Methodological Extensions
Papers adapting the RE-SVAR framework to other policy areas (fiscal, regulatory)
Studies extending the method to higher-dimensional systems
Research incorporating time-varying parameters in the RE-SVAR framework
Papers developing Bayesian versions of the methodology
Empirical Applications
Studies applying the method to other countries or monetary unions
Research examining specific historical episodes with the new methodology
Papers using the framework to analyze unconventional policy periods
Analysis of the method’s performance during structural breaks
Papers Relevant to Chen & Valcarcel (2025)
Chen, Zhengyang, and Victor J. Valcarcel. “Modeling inflation expectations in forward-looking interest rate and money growth rules.” Journal of Economic Dynamics and Control 170 (January 2025): 104999. https://doi.org/10.1016/j.jedc.2024.104999.
Foundational VAR and Monetary Policy Literature
Bernanke, B. S., & Blinder, A. S. (1992). The federal funds rate and the channels of monetary transmission. American Economic Review, 82(4), 901-921.
This seminal paper established the federal funds rate as the primary indicator of monetary policy stance in VAR models, providing the baseline against which Chen & Valcarcel’s money growth rule approach can be compared. The authors’ finding that money growth rules outperform interest rate rules directly challenges this foundational work’s emphasis on interest rates.
Christiano, L. J., Eichenbaum, M., & Evans, C. L. (1999). Monetary policy shocks: What have we learned and to what end? Handbook of Macroeconomics, 1, 65-148.
This comprehensive survey documented the price puzzle problem and proposed adding commodity prices to resolve it, representing the traditional approach of expanding the information set in VARs. Chen & Valcarcel offer an alternative solution by changing the policy indicator rather than adding variables, directly addressing the same puzzles this influential survey identified.
Eichenbaum, M. (1992). Comment on interpreting the macroeconomic time series facts: the effects of monetary policy. European Economic Review, 36(2-3), 1001-1011.
Eichenbaum coined the term “price puzzle” that motivates much of Chen & Valcarcel’s research. Their paper provides a novel solution to the exact problem Eichenbaum identified, showing that money growth rules largely eliminate these puzzling responses.
Bernanke, B. S., Boivin, J., & Eliasz, P. (2005). Measuring the effects of monetary policy: a factor-augmented vector autoregressive (FAVAR) approach. Quarterly Journal of Economics, 120(1), 387-422.
This highly cited paper introduced FAVARs as a solution to information problems in monetary VARs by dramatically expanding the variable set. Chen & Valcarcel’s approach offers a theoretical alternative that maintains low dimensionality while addressing similar identification concerns through rational expectations.
Rational Expectations and DSGE Literature
Lucas Jr, R. E. (1972). Expectations and the neutrality of money. Journal of Economic Theory, 4(2), 103-124.
Lucas’s revolutionary work established rational expectations as fundamental to macroeconomic modeling, providing the theoretical foundation that Chen & Valcarcel build upon. Their RE-SVAR methodology directly operationalizes Lucas’s insights in an empirical VAR framework.
Taylor, J. B. (1993). Discretion versus policy rules in practice. Carnegie-Rochester Conference Series on Public Policy, 39, 195-214.
Taylor’s influential rule established the benchmark for interest rate policy rules that Chen & Valcarcel compare against. Their finding that money growth rules outperform Taylor-type rules provides empirical evidence for reconsidering this widely adopted policy framework.
Woodford, M. (2003). Interest and Prices: Foundations of a Theory of Monetary Policy. Princeton University Press.
Woodford’s comprehensive treatment of New Keynesian monetary theory emphasizes interest rate rules and largely dismisses money aggregates. Chen & Valcarcel’s empirical findings challenge this theoretical consensus by demonstrating the superior performance of money-based policy indicators.
Galí, J. (2008). Monetary Policy, Inflation, and the Business Cycle: An Introduction to the New Keynesian Framework. Princeton University Press.
This standard New Keynesian textbook emphasizes forward-looking behavior and interest rate rules, providing the theoretical backdrop that Chen & Valcarcel extend. Their RE-SVAR methodology operationalizes the forward-looking elements while challenging the exclusive focus on interest rates.
Monetary Aggregates and Money Demand
Barnett, W. A. (1980). Economic monetary aggregates: an application of index number and aggregation theory. Journal of Econometrics, 14(1), 11-48.
Barnett’s foundational work on Divisia monetary aggregates provides the theoretical basis for the money growth measures Chen & Valcarcel employ. Their empirical success with Divisia M4 validates Barnett’s theoretical insights about proper monetary aggregation.
Belongia, M. T., & Ireland, P. N. (2014). The Barnett critique after three decades: a New Keynesian analysis. Journal of Econometrics, 183(1), 5-21.
This paper reintroduced Divisia aggregates into modern New Keynesian models, providing the theoretical framework that Chen & Valcarcel build upon empirically. Their RE-SVAR results provide strong empirical support for Belongia and Ireland’s theoretical arguments.
Belongia, M. T., & Ireland, P. N. (2022). A reconsideration of money growth rules. Journal of Economic Dynamics and Control, 135, 104312.
This recent theoretical work comparing money growth rules to Taylor rules provides the direct theoretical motivation for Chen & Valcarcel’s empirical investigation. Their empirical findings strongly support Belongia and Ireland’s theoretical conclusions about the superiority of money growth rules.
VAR Methodology and Identification
Blanchard, O., & Perotti, R. (2002). An empirical characterization of the dynamic effects of changes in government spending and taxes on output. Quarterly Journal of Economics, 117(4), 1329-1368.
This influential paper used economic theory to identify structural shocks in VARs without relying on recursive assumptions, pioneering the approach that Chen & Valcarcel extend to monetary policy. Their methodology follows Blanchard and Perotti’s strategy of using theoretical restrictions for identification.
Uhlig, H. (2005). What are the effects of monetary policy on output? Results from an agnostic identification procedure. Journal of Monetary Economics, 52(2), 381-419.
Uhlig’s agnostic identification approach highlighted the sensitivity of VAR results to identification assumptions, motivating the need for the theory-based approach Chen & Valcarcel develop. Their method provides a more theoretically grounded alternative to purely statistical identification strategies.
Arias, J. E., Caldara, D., & Rubio-Ramírez, J. F. (2019). The systematic component of monetary policy in SVARs: an agnostic identification procedure. Journal of Monetary Economics, 101, 1-13.
This paper addressed model uncertainty in monetary policy VARs through set identification, similar to Chen & Valcarcel’s approach of generating clouds of responses. Both papers recognize that single point estimates may be insufficient for robust policy conclusions.
Zero Lower Bound and Unconventional Policy
Wu, J. C., & Xia, F. D. (2016). Measuring the macroeconomic impact of monetary policy at the zero lower bound. Journal of Money, Credit and Banking, 48(2-3), 253-291.
Wu and Xia’s shadow rate provides the interest rate measure Chen & Valcarcel use during the zero lower bound period. Their paper’s methodology complements Chen & Valcarcel’s approach by extending interest rate measures, though the latter’s findings suggest money growth rules may be superior even with these extensions.
Krishnamurthy, A., & Vissing-Jorgensen, A. (2011). The effects of quantitative easing on interest rates: channels and implications for policy. Brookings Papers on Economic Activity, 2011(2), 215-287.
This analysis of QE effects highlights the limitations of traditional interest rate measures during unconventional policy periods. Chen & Valcarcel’s demonstration that money growth rules work well during these periods provides an empirical alternative for analyzing unconventional policy effectiveness.
Price Puzzle and VAR Problems
Ramey, V. A. (2016). Macroeconomic shocks and their propagation. Handbook of Macroeconomics, 2, 71-162.
Ramey’s comprehensive survey documented the persistence of the price puzzle across different VAR specifications and time periods, highlighting the ongoing challenge Chen & Valcarcel address. Their money growth rule approach provides a potential solution to the puzzles Ramey catalogs.
Giordani, P. (2004). An alternative explanation of the price puzzle. Journal of Monetary Economics, 51(6), 1271-1296.
Giordani proposed using output gaps instead of output levels to resolve price puzzles, representing an alternative approach to the problem Chen & Valcarcel tackle. Their method offers a different solution that maintains theoretical consistency while changing the policy indicator.
Hanson, M. S. (2004). The “price puzzle” reconsidered. Journal of Monetary Economics, 51(7), 1385-1413.
Hanson argued that the price puzzle reflects misspecification rather than a true policy effect, similar to Chen & Valcarcel’s view that it indicates problems with interest rate specifications. Their paper provides empirical evidence supporting this interpretation.
Financial Conditions and Monetary Transmission
Gilchrist, S., & Zakrajšek, E. (2012). Credit spreads and business cycle fluctuations. American Economic Review, 102(4), 1692-1720.
The excess bond premium measure developed in this paper is incorporated into Chen & Valcarcel’s four-variable extension, demonstrating how their methodology can accommodate financial variables. This integration shows the flexibility of their approach beyond the core three-variable model.
Gertler, M., & Karadi, P. (2015). Monetary policy surprises, credit costs, and economic activity. American Economic Journal: Macroeconomics, 7(1), 44-76.
This paper examined how monetary policy affects credit conditions, providing context for understanding why money growth rules might better capture policy transmission. Chen & Valcarcel’s findings suggest money aggregates may better reflect these credit channel effects.
Expectations and Forward Guidance
Coibion, O. (2012). Are the effects of monetary policy shocks big or small? American Economic Journal: Macroeconomics, 4(2), 1-32.
Coibion’s analysis of monetary policy shock sizes using Federal Reserve forecasts highlights the importance of expectations in policy transmission. Chen & Valcarcel’s explicit modeling of expectation horizons in policy rules directly addresses these transmission mechanisms.
Bundick, B., & Smith, A. L. (2020). The dynamic effects of forward guidance shocks. Review of Economics and Statistics, 102(5), 946-965.
This analysis of forward guidance effects emphasizes the importance of expectations in modern monetary policy, providing context for Chen & Valcarcel’s focus on forward-looking policy rules. Their methodology offers a way to empirically assess how expectation horizons affect policy transmission.
International and Historical Perspectives
Clarida, R., Galí, J., & Gertler, M. (2000). Monetary policy rules and macroeconomic stability: evidence and some theory. Quarterly Journal of Economics, 115(1), 147-180.
This influential paper on monetary policy rules across countries and time periods provides the international context for evaluating Chen & Valcarcel’s findings. Their methodology could be applied to test whether money growth rules outperform interest rate rules internationally.
Orphanides, A. (2001). Monetary policy rules based on real-time data. American Economic Review, 91(4), 964-985.
Orphanides’ work on real-time policy analysis highlights the practical challenges of implementing policy rules, providing context for Chen & Valcarcel’s findings about rule performance. Their results suggest money growth rules might be more robust to real-time implementation challenges.
Methodological Extensions and Related Approaches
Fernández-Villaverde, J., Rubio-Ramírez, J. F., Sargent, T. J., & Watson, M. W. (2007). ABCs (and Ds) of understanding VARs. American Economic Review, 97(3), 1021-1026.
This paper explored the relationship between DSGE models and VARs, addressing similar questions about theory-data integration that motivate Chen & Valcarcel’s approach. Their RE-SVAR methodology provides an alternative way to bridge this theory-empirics divide.
Keating, J. W. (1992). Structural approaches to vector autoregressions. Federal Reserve Bank of St. Louis Review, 74(5), 37-57.
Keating’s early work on using economic theory to identify structural VARs pioneered the approach Chen & Valcarcel extend to incorporate rational expectations. Their methodology builds directly on this foundation while adding forward-looking elements.
Behavioral Macroeconomics and Expectation Formation
Mankiw, N. G., & Reis, R. (2002). Sticky information versus sticky prices: a proposal to replace the New Keynesian Phillips curve. Quarterly Journal of Economics, 117(4), 1295-1328.
This paper challenged the rational expectations assumption by proposing sticky information models, providing an alternative framework for understanding expectation formation. Chen & Valcarcel’s explicit modeling of expectation horizons offers a way to empirically test how different expectation formation mechanisms affect policy transmission.
Carroll, C. D. (2003). Macroeconomic expectations of households and professional forecasters. Quarterly Journal of Economics, 118(1), 269-298.
Carroll’s work on heterogeneous expectations and the role of professional forecasters in expectation formation provides context for Chen & Valcarcel’s rational expectations framework. Their methodology could be extended to incorporate survey-based expectations to test robustness to alternative expectation formation processes.
Coibion, O., & Gorodnichenko, Y. (2012). What can survey forecasts tell us about information rigidities? Journal of Political Economy, 120(1), 116-159.
This influential paper used survey data to test theories of expectation formation, highlighting deviations from rational expectations. Chen & Valcarcel’s assumption of rational expectations could be tested against these empirical findings about actual expectation formation.
Coibion, O., & Gorodnichenko, Y. (2015). Information rigidity and the expectations formation process: A simple framework and new facts. American Economic Review, 105(8), 2644-2678.
This paper provided extensive evidence on how expectations actually form, showing systematic deviations from rational expectations. Chen & Valcarcel’s framework provides a benchmark rational expectations case that could be compared with these behavioral findings.
Computational Methods and Machine Learning
Stock, J. H., & Watson, M. W. (2002). Macroeconomic forecasting using diffusion indexes. Journal of Business & Economic Statistics, 20(2), 147-162.
This seminal work on factor models for macroeconomic forecasting represents an alternative approach to handling high-dimensional information sets compared to Chen & Valcarcel’s low-dimensional theoretical approach. Their methodology offers a more structured alternative to purely statistical dimension reduction.
Bai, J., & Ng, S. (2002). Determining the number of factors in approximate factor models. Econometrica, 70(1), 191-221.
This paper established the theoretical foundation for factor model selection, providing the statistical basis for high-dimensional approaches that Chen & Valcarcel’s method offers an alternative to. Their theoretically grounded low-dimensional approach contrasts with these data-driven dimension reduction techniques.
Coulombe, P. G., Leroux, M., Stevanovic, D., & Surprenant, S. (2022). How is machine learning useful for macroeconomic forecasting? Journal of Applied Econometrics, 37(5), 920-964.
This recent survey of machine learning applications in macroeconomics provides context for evaluating Chen & Valcarcel’s more traditional econometric approach. Their method’s theoretical grounding offers interpretability advantages over black-box ML approaches.
Financial Frictions and Credit Channels
Bernanke, B. S., Gertler, M., & Gilchrist, S. (1999). The financial accelerator in a quantitative business cycle framework. Handbook of Macroeconomics, 1, 1341-1393.
This foundational work on financial frictions in macroeconomic models provides theoretical context for why money aggregates might better capture policy transmission than interest rates alone. Chen & Valcarcel’s empirical success with money growth rules may reflect these financial accelerator mechanisms.
Kashyap, A. K., & Stein, J. C. (2000). What do a million observations on banks say about the transmission of monetary policy? American Economic Review, 90(3), 407-428.
This influential analysis of the bank lending channel suggests that monetary policy works through bank balance sheets, not just interest rates. Chen & Valcarcel’s finding that money aggregates outperform interest rates may capture these credit channel effects more effectively.
Adrian, T., & Shin, H. S. (2010). Liquidity and leverage. Journal of Financial Intermediation, 19(3), 418-437.
This paper on financial intermediary balance sheets and monetary transmission provides microfoundations for why money aggregates might be superior policy indicators. Chen & Valcarcel’s empirical results align with this view that balance sheet effects are central to monetary transmission.
International Monetary Economics
Obstfeld, M., & Taylor, A. M. (2004). Global Capital Markets: Integration, Crisis, and Growth. Cambridge University Press.
This comprehensive analysis of international capital markets provides context for evaluating monetary policy effectiveness in open economies. Chen & Valcarcel’s methodology could be extended to examine whether money growth rules are superior internationally.
Ilzetzki, E., Reinhart, C. M., & Rogoff, K. S. (2019). Exchange rate arrangements entering the twenty-first century: Which anchor will hold? Quarterly Journal of Economics, 134(2), 599-646.
This analysis of exchange rate regimes globally provides context for understanding different monetary policy frameworks internationally. Chen & Valcarcel’s findings about money growth rules could inform debates about optimal policy frameworks for different exchange rate regimes.
Rey, H. (2015). Dilemma not trilemma: the global financial cycle and monetary policy independence. NBER Working Paper No. 21162.
Rey’s work on the global financial cycle and monetary policy independence raises questions about the effectiveness of traditional policy tools. Chen & Valcarcel’s methodology could help evaluate how different policy indicators perform under global financial constraints.
Fiscal-Monetary Interactions
Leeper, E. M. (1991). Equilibria under ‘active’ and ‘passive’ monetary and fiscal policies. Journal of Monetary Economics, 27(1), 129-147.
Leeper’s analysis of fiscal-monetary policy coordination provides theoretical context for understanding how monetary policy effectiveness depends on the broader policy mix. Chen & Valcarcel’s framework could be extended to examine fiscal-monetary interactions.
Sims, C. A. (2011). Stepping on a rake: The role of fiscal policy in the inflation of the 1970s. European Economic Review, 55(1), 48-56.
Sims’s analysis of fiscal contributions to inflation highlights the importance of considering broader policy interactions when evaluating monetary policy. Chen & Valcarcel’s methodology could incorporate fiscal variables to test robustness.
Davig, T., & Leeper, E. M. (2011). Monetary-fiscal policy interactions and fiscal stimulus. European Economic Review, 55(2), 211-227.
This paper on policy interactions during crisis periods provides context for Chen & Valcarcel’s analysis of monetary policy effectiveness during unconventional periods. Their methodology could help evaluate policy coordination during crises.
Central Bank Communication and Transparency
Blinder, A. S., Ehrmann, M., Fratzscher, M., De Haan, J., & Jansen, D. J. (2008). Central bank communication and monetary policy: a survey of theory and evidence. Journal of Economic Literature, 46(4), 910-945.
This comprehensive survey of central bank communication research provides context for understanding how policy transmission depends on communication strategies. Chen & Valcarcel’s focus on policy rules relates to how central banks communicate their systematic behavior.
Gürkaynak, R. S., Sack, B., & Swanson, E. (2005). The sensitivity of long-term interest rates to economic news: evidence and implications for macroeconomic models. American Economic Review, 95(1), 425-436.
This paper on how markets respond to economic news provides evidence on expectation formation that relates to Chen & Valcarcel’s modeling of forward-looking policy rules. Their methodology could incorporate market-based measures of expectations.
Campbell, J. R., Evans, C. L., Fisher, J. D., & Justiniano, A. (2012). Macroeconomic effects of Federal Reserve forward guidance. Brookings Papers on Economic Activity, 2012(1), 1-80.
This analysis of forward guidance effects relates directly to Chen & Valcarcel’s emphasis on forward-looking policy rules. Their methodology provides a framework for evaluating how different expectation horizons affect policy transmission.
Housing and Sectoral Effects
Iacoviello, M. (2005). House prices, borrowing constraints, and monetary policy in the business cycle. American Economic Review, 95(3), 739-764.
This influential paper on housing’s role in monetary transmission suggests sectoral heterogeneity in policy effects. Chen & Valcarcel’s methodology could be extended to examine whether money growth rules better capture these sectoral transmission channels.
Mishkin, F. S. (2007). Housing and the monetary transmission mechanism. Federal Reserve Bank of Kansas City Economic Review, 92(4), 5-35.
Mishkin’s analysis of housing in monetary transmission provides additional context for understanding why traditional interest rate measures might be insufficient. Chen & Valcarcel’s money aggregate approach might better capture these diverse transmission channels.
Labor Markets and Phillips Curve
Galí, J., & Gertler, M. (1999). Inflation dynamics: A structural econometric analysis. Journal of Monetary Economics, 44(2), 195-222.
This foundational New Keynesian Phillips curve paper emphasizes forward-looking inflation dynamics, providing theoretical support for Chen & Valcarcel’s forward-looking approach. Their empirical methodology operationalizes these theoretical insights.
Sbordone, A. M. (2002). Prices and unit labor costs: a new test of price stickiness. Journal of Monetary Economics, 49(2), 265-292.
Sbordone’s work on price stickiness and inflation dynamics provides microeconomic foundations for the aggregate relationships Chen & Valcarcel model. Their framework could incorporate labor market variables to test these microfoundations.
Christiano, L. J., Eichenbaum, M., & Evans, C. L. (2005). Nominal rigidities and the dynamic effects of a shock to monetary policy. Journal of Political Economy, 113(1), 1-45.
This paper’s detailed analysis of price and wage rigidities provides theoretical context for Chen & Valcarcel’s Phillips curve specification. Their empirical approach could test the robustness of these theoretical assumptions.
Emerging Markets and Development
Calvo, G. A., & Reinhart, C. M. (2002). Fear of floating. Quarterly Journal of Economics, 117(2), 379-408.
This analysis of exchange rate regimes in emerging markets provides context for evaluating monetary policy frameworks internationally. Chen & Valcarcel’s methodology could examine whether money growth rules are particularly effective in emerging market contexts.
Taylor, J. B. (2001). The role of the exchange rate in monetary-policy rules. American Economic Review, 91(2), 263-267.
Taylor’s extension of policy rules to open economies provides a framework for international applications of Chen & Valcarcel’s methodology. Their approach could compare interest rate versus money growth rules in open economy settings.
Real-Time Data and Policy Implementation
Orphanides, A. (2001). Monetary policy rules based on real-time data. American Economic Review, 91(4), 964-985.
This seminal work on real-time policy implementation highlights practical challenges of policy rules, providing context for evaluating Chen & Valcarcel’s findings. Their results suggest money growth rules might be more robust to real-time data limitations.
Croushore, D., & Stark, T. (2001). A real-time data set for macroeconomists. Journal of Econometrics, 105(1), 111-130.
This paper established the real-time database that enables testing policy rules with realistic information sets. Chen & Valcarcel’s methodology could be tested using real-time data to evaluate practical implementation.
Non-Linear and Regime-Switching Models
Hamilton, J. D. (1989). A new approach to the economic analysis of nonstationary time series and the business cycle. Econometrica, 57(2), 357-384.
Hamilton’s regime-switching framework provides an alternative approach to modeling structural change that could complement Chen & Valcarcel’s analysis. Their methodology could incorporate regime-switching to account for changing policy effectiveness.
Sims, C. A., & Zha, T. (2006). Were there regime switches in US monetary policy? American Economic Review, 96(1), 54-81.
This analysis of monetary policy regime changes provides context for Chen & Valcarcel’s sample period analysis. Their methodology could explicitly model regime changes in policy rule effectiveness.
Zhengyang (Robin) Chen
Assistant Professor in Economics
My research interests include Macroeconomics and Monetary Economics, Time Series Analysis and Financial Markets.