Decomposing the effects of monetary policy using an external instruments SVAR

Lakdawala, Aeimit

doi:10.1002/jae.2721

Cited by 43 publications

(21 citation statements)

References 70 publications

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“…Del Negro, Giannoni and Patterson (2012) show that standard New Keynesian dynamic stochastic general equilibrium (DSGE) models predict incredibly strong positive impacts of forward guidance policies on future inflation and activity, a result that has been dubbed the forward guidance puzzle. The authors' exercise implicitly assumes that the yield curve reaction to for-6 See also Lakdawala (2017). D'Amico and King (2015) rely on survey data together with exclusion and sign restrictions in a VAR model of quarterly data.…”

Section: Related Literaturementioning

confidence: 99%

Delphic and Odyssean Monetary Policy Shocks: Evidence from the Euro Area

Andrade

Ferroni

2019

Federal Reserve Bank of Boston Research Department Working Papers

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What drives the strong reaction of financial markets to central bank communication on the days of policy decisions? We highlight the role of two factors that we identify from highfrequency monetary surprises: news on future macroeconomic conditions (Delphic shocks) and news on future monetary policy shocks (Odyssean shocks). These two shocks move the yield curve in the same direction but have opposite effects on financial conditions and macroeconomic expectations. A drop in future interest rates that is associated with a negative Delphic (Odyssean) shock is perceived as being contractionary (expansionary). These offsetting effects can explain why central bank communication leads to a strong reaction of the yield curve together with a weak reaction by inflation expectations or stock prices. The two shocks also have different impacts on macroeconomic outcomes, such that central bankers cannot infer the degree of stimulus they provide by looking at the mere reaction of the yield curve. However, changes in their communication policy can influence the way markets predominantly understand communication about future interest rates. JEL Classifications: E52, E32, C10

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Section: Related Literaturementioning

confidence: 99%

Delphic and Odyssean Monetary Policy Shocks: Evidence from the Euro Area

Andrade

Ferroni

2019

Federal Reserve Bank of Boston Research Department Working Papers

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“…For the same reason, I focus on regular FOMC meetings and do not include unscheduled FOMC meetings. Nevertheless, even with these constraints, an information release cannot be completely excluded, but rather the results show that the surprises that I use are much less likely to be confounded in this way.2 SeeAndrade and Ferroni (2016),Campbell et al (2012Campbell et al ( , 2017,Cieslak and Schrimpf (2018),Lakdawala (2017),Jarocinski and Karadi (2018), and Miranda-Agrippino and Ricco (2017) for alternative approaches of identifying the importance or reducing the influence of information shocks.3 Bagliano and Favero (1999) have used a VARX in a similar way, but did not show that this approach consistently identifies the true (relative) impulse responses. 4 A relative impulse response normalizes the initial response of one of the endogenous variables, but leaves the response of the rest of the variables unrestricted.…”

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confidence: 90%

The Time-Varying Effect of Monetary Policy on Asset Prices

Paul

2020

Review of Economics and Statistics

135

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This paper studies how monetary policy jointly affects asset prices and the real economy in the United States. I develop an estimator that uses high-frequency surprises as a proxy for the structural monetary policy shocks. This is achieved by integrating the surprises into a vector autoregressive model as an exogenous variable. I use current short-term rate surprises because these are least affected by an information effect.When allowing for time-varying model parameters, I find that, compared to the response of output, the reaction of stock and house prices to monetary policy shocks was particularly low before the 2007-09 financial crisis.Second, I find that stock and house prices show substantial time-variation to unanticipated changes in monetary policy. While the response of stock prices does not show a systematic pattern, the response of house prices strongly comoves with the level of house prices over most of the sample.They are less responsive when house prices are high, and more responsive when prices are low.Third, I find that, compared to output, the response of stock and house prices was particularly low before the Great Recession. Hence, attempts by the Federal Reserve to lean against the house price boom before the crisis may have been less effective.Apart from the application in this paper, the exogenous variable approach can generally be applied when a proxy for the structural shock of interest is available. In this regard, the method is an alternative implementation of the external instrument or proxy SVAR approach, introduced by Stock and Watson (2012) and Mertens and Ravn (2013). 5,6 Gertler and Karadi (2015) and Caldara and Herbst (2016) apply this method in the context of monetary policy identification.Both approaches consistently estimate the true relative impulse responses and I provide analytical derivations with respect to their equivalence. However, they use the proxy differently; once as an exogenous variable and the other time as an external instrument. In a comparison of these two methods, the exogenous variable approach allows for the simple extension with time-varying parameters since the VAR is estimated in a single step. In addition, I also compare the exogenous variable approach with the local projection instrumental variable approach (LP-IV), as proposed by Stock and Watson (2018) among others. 7The response of stock prices to monetary policy news (e.g, Bernanke and Kuttner, 2005, Rigobon andSack, 2004) or macroeconomic news more generally (e.g., Law, Song, and Yaron, 2017) is well explored in the literature. However, the relation is typically analyzed by the immediate response within a narrow window around news releases. 8 In contrast, this paper identifies the dynamic response of stock prices to monetary policy shocks. The reaction of house prices to monetary policy shocks is less explored, but interest in this question increased after the 2007-09 financial crisis. Kuttner (2013) provides an overview of the empirical findings.Last, I focus on the response of asset prices to ...

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“…Finally, on the methodological side we contribute to the fast growing literature that exploits information from external variables to identify dynamic causal effects in proxy-SVARs (SVARs-IV) in the special case in which multiple instruments are used for multiple target shocks; see e.g. Mertens and Ravn (2013), Mertens and Montiel Olea (2018), Lakdawala (2019) and Angelini and Fanelli (2019). To our knowledge, ours is the first contribution in the proxy-SVAR/monetary policy context where three structural shocks are point-identified simultaneously.…”

Section: Connections With the Literaturementioning

confidence: 97%

Unconventional Monetary Policy in the Euro Area: A Tale of Three Shocks

Fanelli

Marsi

2021

SSRN Journal

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High-frequency (HF) surprises of relevant asset prices around central bank meetings are extensively employed in the literature to identify the effects of conventional/unconventional monetary policy. This identification strategy assumes that these surprises reflect either a single unconventional 'monetary shock' or, as recently suggested, jointly an unconventional monetary shock and a central bank 'information shock'. In this paper we show that monetary policy in the euro area after 2008 is best characterized by three shocks, not two. Besides the unconventional monetary shock and the information shock, we consider a third shock resulting from the ECB directly managing fragmentation risk in the sovereign bond market.We call this additional shock 'spread shock', and show that it permits to solve a puzzle we observe in HF comovement of long term risk free rates and sovereign spreads around press conferences. We identify the dynamic causal effects produced by the three shocks through a proxy-SVAR methodology which, using HF surprises of the euro area risk-free yield curve, stock prices and sovereign spreads, combines sign-restrictions with narrative restrictions and then extracts external variables (instruments) from an admissible identification set. Empirical results, obtained through a daily proxy-SVAR and Local Projections based on monthly data, reveal that the spread shock represents an important ingredient of the transmission mechanism of the monetary policy after the Global Financial Crisis. It reflects ECB's attempt to offset self-fulling expectations of default in the euro area sovereign debt markets and behaves as a complement, not a substitute of the information shock.

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Decomposing the effects of monetary policy using an external instruments SVAR

Cited by 43 publications

References 70 publications

Delphic and Odyssean Monetary Policy Shocks: Evidence from the Euro Area

Delphic and Odyssean Monetary Policy Shocks: Evidence from the Euro Area

The Time-Varying Effect of Monetary Policy on Asset Prices

Unconventional Monetary Policy in the Euro Area: A Tale of Three Shocks

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