Overnight Rate Innovations as a Measure of Monetary Policy Shocks in Vector Autoregressions

The authors examine the Bank of Canada's overnight rate as a measure of monetary policy in vector autoregression (VAR) models. Since the time series of the Bank's current measure of the overnight rate begins only in 1971, the authors splice it to day loan rate observations to obtain a sufficiently long period of data. The resulting series, called Ron, extends back to the 1950s.

The authors' analysis yields four findings of interest: First, Ron innovations and innovations of the Bank's current overnight rate measure appear to incorporate virtually identical information about monetary policy shocks. Second, the path of Ron innovations provides a reasonable account of the evolution of monetary policy actions over the past 35 years. Third, shocking Ron in VAR systems has consequences for output, prices and the exchange rate that might be expected from a monetary policy shock. Finally, as a monetary policy variable in these VAR systems, Ron performs at least as well as either the 90-day paper rate or the term spread.

The main conclusions are that Ron, the overnight rate variable developed by the authors, provides a good basis for measuring monetary policy actions in VAR-based analysis and that Ron innovations can provide a good measure of monetary policy shocks.