RDP 2020-01: Credit Spreads, Monetary Policy and the Price Puzzle Appendix A: Literature Review

For Australia, early research finds mixed evidence for the response of prices to monetary policy (no price puzzle in Dungey and Pagan (2000); Berkelmans (2005); price puzzle in Suzuki (2004); Beechey and Österholm (2008); Lawson and Rees (2008)). Brischetto and Voss (1999) find that controlling for US interest rates and the Australian dollar exchange rate is crucial to remove the price puzzle. Using more recent data, Jacobs and Rayner (2012) and Phan (2014) find strong price puzzles even in similar (successful) specifications to the earlier Australian research. This has raised the question whether identification of the effects of monetary policy in Australia has become more difficult since the advent of inflation targeting in the early 1990s. Using a simulation study, Jääskelä and Jennings (2010) find that standard identification schemes typically deliver a price puzzle and hence suggest using a sign-restriction identification approach which delivers the desired response by construction. Most recently, Hartigan and Morley (2018) propose that the price puzzle can be resolved using a factor augmented VAR (FAVAR), which better accounts for the vast information the Bank uses when producing its forecasts.