Using a panel of survey-based measures of future interest rates from the Survey of Professional Forecasters, we study the dynamic relationship between shocks to monetary policy expectations and fluctuations in economic activity and inflation. We propose a smallscale structured recursive vector autoregression (VAR) model to identify the macroeconomic effects of changes in expectations about monetary policy. Our results show that when interest rates are away from the zero-lower bound, a perception of higher future interest rates leads to a significant rise in current measures of inflation and a rise in economic activity. However, when interest rates approach zero, the effect on economic activity is the opposite, with significant but lagged decreases in economic activity following an upward revision to expected future interest rates. The impact of changes in expectations about monetary policy is robust when we control for other features of the transmission mechanism (e.g., long-term interest rates, quantitative easing, exchange rate movements and even oil price shocks). Our findings also show that monetary policy expectations contribute up to 34 percent to the variability of economic activity (and 24 percent on inflation) while policy rates are fixed at the zero-lower bound. This evidence points to the importance of managing monetary policy expectations (forward guidance) as a crucial policy tool for stimulating economic activity at the zero-lower bound.
Using a panel of survey-based measures of future interest rates from the Survey of Professional Forecasters, we study the dynamic relationship between shocks to monetary policy expectations and fluctuations in economic activity and inflation. We propose a smallscale structured recursive vector autoregression (VAR) model to identify the macroeconomic effects of changes in expectations about monetary policy. Our results show that when interest rates are away from the zero-lower bound, a perception of higher future interest rates leads to a significant rise in current measures of inflation and a rise in economic activity. However, when interest rates approach zero, the effect on economic activity is the opposite, with significant but lagged decreases in economic activity following an upward revision to expected future interest rates. The impact of changes in expectations about monetary policy is robust when we control for other features of the transmission mechanism (e.g., long-term interest rates, quantitative easing, exchange rate movements and even oil price shocks). Our findings also show that monetary policy expectations contribute up to 34 percent to the variability of economic activity (and 24 percent on inflation) while policy rates are fixed at the zero-lower bound. This evidence points to the importance of managing monetary policy expectations (forward guidance) as a crucial policy tool for stimulating economic activity at the zero-lower bound.
Using a panel of survey-based measures of future interest rates from the Survey of Professional Forecasters, we study the dynamic relationship between shocks to monetary policy expectations and fluctuations in economic activity and inflation. We propose a smallscale structured recursive vector autoregression (VAR) model to identify the macroeconomic effects of changes in expectations about monetary policy. Our results show that when interest rates are away from the zero-lower bound, a perception of higher future interest rates leads to a significant rise in current measures of inflation and a rise in economic activity. However, when interest rates approach zero, the effect on economic activity is the opposite, with significant but lagged decreases in economic activity following an upward revision to expected future interest rates. The impact of changes in expectations about monetary policy is robust when we control for other features of the transmission mechanism (e.g., long-term interest rates, quantitative easing, exchange rate movements and even oil price shocks). Our findings also show that monetary policy expectations contribute up to 34 percent to the variability of economic activity (and 24 percent on inflation) while policy rates are fixed at the zero-lower bound. This evidence points to the importance of managing monetary policy expectations (forward guidance) as a crucial policy tool for stimulating economic activity at the zero-lower bound.
for helpful suggestions. We gratefully acknowledge the research assistance provided by Bradley Graves, Valerie Grossman and Jarod Coulter, and the support of the Federal Reserve Bank of Dallas. We also extend our thanks to Ben Leubsdorf at the Wall Street Journal for assisting in providing data. We base our econometric analysis on the Stata package pvar of Inessa Love and pvar2 of Ryan A. Decker together with the Matlab codes of Haroon Mumtaz, Andrew Binning, and Ambrogio Cesa-Bianchi's Matlab VAR Toolbox 2.0. All remaining errors are ours alone. Rachel Doehr worked on this paper partly as a visitor at the Federal Reserve Bank of Dallas, whose support is sincerely appreciated, while at Claremont McKenna College. Rachel Doehr contributed to this paper in her personal capacity. The information, views, and opinions expressed herein are solely her own and do not necessarily represent the views of Point72. Point72 is not responsible for, and did not verify for accuracy, any of the information contained herein. The views expressed in this paper are those of the authors and do not necessarily reflect the views of the Federal Reserve Bank of Dallas or the Federal Reserve System.
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