The Instability in the Monetary Policy Reaction Function and the Estimation of Monetary Policy Shocks

Kishor, N. Kundan and Newiak, Monique (2009): The Instability in the Monetary Policy Reaction Function and the Estimation of Monetary Policy Shocks.

Abstract

This paper uses the conventional wisdom about the shift in the monetary policy stance in 1979 to compute monetary policy shocks by estimating different monetary policy reaction functions for the pre-1979 and post-1979 time periods. We use the information from the internal forecasts of the Federal Reserve to derive monetary policy shocks. The results in this paper show that a monetary policy shock in the pre-1979 period affects output and prices much more strongly and quickly than what has been reported in the literature for the full sample. Our findings suggest that the dynamic response of output and prices to a monetary policy shock declined significantly between 1980-2001. We argue that this diminished response to the monetary policy shock is the result of a successful monetary policy that has led to a less volatile economy.

• Item Type: MPRA Paper
• Language: English
• Keywords: Monetary Policy Shocks, Greenbook data, Reaction Function
• Subjects: E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations ; Cycles; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E58 - Central Banks and Their Policies; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy

References

Barth, Marvin, and Valerie A. Ramey (2001), "The Cost Channel of Monetary Transmission", NBER Macroeconomics Annual 2001.

Bernanke, Ben S., and Alan S. Blinder (1992), "The Federal Funds Rate and the Channels of Monetary Transmission" The American Economic Review, Vol. 82, No. 4 (Sep.), 901-21.

Bernanke, Ben S., Mark Gertler, Mark Watson, Christopher A. Sims, and Benjamin M. Friedman (1997), "Systematic Monetary Policy and the Effects of Oil Price Shocks", Brookings Papers on Economic Activity, Iss. 1, 91-157.

Bernanke, Ben S., and Ilian Mihov (1998), "Measuring Monetary Policy", The Quarterly Journal of Economics, Vol. 113, No. 3 (Aug.), 869-902.

Bils, Mark and Peter J. Klenow (2004), "Some Evidence on the Importance of Sticky Prices", Journal of Political Economy, Vol. 112, No. 5, 947-985.

Boivin, Jean, and Marc P. Giannoni (2002), "Assessing Changes in the Monetary Transmission Mechanism: A VAR Approach", Economic Policy Review, May, 97-107.

Boivin, Jean, and Marc P. Giannoni (2006), "Has Monetary Policy Become More Effective?", The Review of Economics and Statistics, Vol. 88, No. 3 (Aug.), 445-62.

Christiano, Lawrence, Martin Eichenbaum and Charles Evans (1996), "Monetary policy shocks: what have we learned and to what end?", In: Michael Woodford and John Taylor, eds, Handbook of Macroeconomics North Holland.

Clarida, Richard, Jordi Gali, and Mark Gertler (1999), "The Science of Monetary Policy: A New Keynesian Perspective", In: Journal of Economic Literature, Vol. 37 (December 1999), 1661-07.

Clarida, Richard, Jordi Gali and Mark Gertler (2000), "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory", Quarterly Journal of Economics, Vol. 115, No. 1 (Feb.), 147-80.

Cochrane, John H. (1998), "What do the VARs Mean? Measuring the Output Effects of Monetary Policy", Journal of Monetary Economics, Vol. 41, Iss. 2 (Apr.), 277-300.

Cochrane, John H. (2004), "Comments on 'A new measure of monetary shocks: Derivation and implications'", presented at NBER EFG meeting (July).

Favero, Carlo A. and Riccardo Rovelli (2003), "Macroeconomic Stability and the Preferences of the Fed: A Formal Analysis, 1961-98", Journal of Money, Credit and Banking, Vol. 35, No. 4, 545-556.

Gali, Jordi (2008): "Monetary Policy, Inflation, and the Business Cycle: An Introduction to the New Keynesian Framework", Princeton University Press, Princeton, NJ.

Gertler, Mark, and Cara S. Lown (2000), "The Information in the High-Yield Bond Spread for the Business Cycle: Evidence and Some Implications", NBER working paper no. 7549.

Kahn, James A., Margaret M. McConnell, and Gabriel Perez-Quiros (2002), "On the Causes of the Increased Stability of the U.S. Economy", Economic Policy Review, May, 183-201.

Kishor, N. Kundan, and Levis A. Kochin (2006): "The Success of the Fed and the Death of Monetarism", Economic Inquiry, Vol. 45, No. 1 (Jan.), 56-70.

Kuttner, Kenneth N., and Patricia C. Mosser (2002): "The Monetary Transmission Mechanism: Some Answers and Further Questions", FRBNY Policy Review, May, 15-26.

McConnell, Margaret M., and Gabriel Perez-Quiros (2000), "Output Fluctuations in the United States: What has Changed Since the Early 1980's?", The American Economic Review, Vol. 90, No. 5 (Dec.), 1464-76.

Nakamura, Emi, and Jon Steinsson (2008), "Five Facts about Prices: A Reevaluation of Menu Cost Models", The Quartlerly Journal of Economics, Iss. 4 (November), 1415-64. Orphanides, Athanasios (2001), "Monetary Policy Rules Based on Real-Time Data", American Economic Review, Vol. 91, No. 4 (Sep.), 964-85.

Orphanides, Athanasios (2002): "Monetary Policy and the Great Inflation", American Economic Review, Vol. 92, No. 2 (May), 115-20.

Orphanides, Athanasios (2004), "Monetary Policy Rules, Macroeconomic Stability and Inflation", Journal of Money, Credit and Banking, Vol. 36, No. 2 (Apr.), 151-75.

Romer, Christina D., and David H. Romer (2004), "A New Measure of Monetary Shocks: Derivation and Implications", The American Economic Review, Vol. 94, No. 4 (Sep.), 1055-84.

Senda, Takashi (2005), "Determining Output and Inflation Variability: Are the Phillips Curve and the Monetary Policy Reaction Function Responsible", Economic Inquiry, Vol. 43, No. 2, 431-453.

Taylor, John B. (1999), " Staggered Price and Wage Setting in Macroeconomics", in J.B. Taylor and M. Woodford eds., Handbook of Macroeconomics, chapter 15, 1341-97, Elsevier, New York.

Tchaidze, Robert (2004), "The Greenbook and U. S. Monetary Policy", IMF working paper, WP/04/213.