A New Keynesian Perspective of Monetary Policy Implementation in Australia

Abstract

We estimate a structural VAR (SVAR) for the Australian economy based on an open economy New Keynesian macro model. The identification of the rational expectations SVAR is achieved by placing exclusion restrictions on the VAR residuals and the covariance matrix. The full information maximum likelihood parameter estimates of the model suggest that the New Keynesian specification fits the Australian data well, and the Reserve Bank of Australia (RBA) has a short-run focus on stabilising the output fluctuations while maintaining a medium-run inflation target since 1984. We simulate the dynamic responses of the output gap, inflation, exchange rate, and interest rate to an exogenous monetary policy shock. The results are clear of the price and exchange rate puzzles, which further supports the relevance of the New Keynesian model to the Australian economy. The impulse response functions for an exchange rate shock and for an aggregate demand shock suggest that the RBA is primarily concerned about the effects of the exchange rate fluctuations on inflation and output in the short run.