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MONETARY POLICY EFFECTS IN AN AUSTRALIAN BAYESIAN VAR MODEL

The objective of the structural VAR model developed in this paper is to identify the effects of Australian monetary policy on the economy, within a small open economy framework. The methodology applied is the Bayesian techniques of Sims and Zha (1998) and Waggoner and Zha (2000) to incorporate prior information into the VAR model. Results consistent with economic theory are achieved by employing a block exogeneity assumption combined with additional contemporaneous and lagged linear restrictions. The paper examines the effects of introducing a mark-up pricing model restriction in to the monetary policy environment. In summary, the effects of restricting the model with this assumption, in comparison to the base model, is to lengthen the negative output gap produced by a wage inflation shock. Conversely, a price inflation shock induces a relatively larger fall in real wages that subsequently leads to a more pronounced above trend phase in output. The effect of a cash rate increase in the mark-up restricted model is to have a very similar effect on reducing the level of GDP to the unrestricted case.