Identification of Monetary Policy Shocks with External Instrument SVAR

Abstract

We explore the use of external instrument SVAR to identify monetary policy shocks. We identify a forward guidance shock as the monetary shock component having zero instant impact on the policy rate. A contractionary forward guidance shock raises both future output and price level, stressing the relative importance of revealing policymakers' view on future output and price level over committing to a policy stance. We also decompose nonmonetary structural shocks, and find that positive shocks to output and price level lead to monetary contraction. Since information on output and price level is revealed through both monetary and non-monetary channels, some monetary and non-monetary shocks can look alike, leading to linear dependence and violating usual instrument SVAR assumptions. We show that some of the main findings are robust to such dependence. *

The Federal Reserve’s Current Framework for Monetary Policy: A Review and Assessment

“…These papers interpret shocks to the slope of the yield curve as forward guidance surprises, but they may also include elements of LSAPs, especially since the two kinds of announcements often came out concurrently. Bundick and Smith (2018) find that forward guidance shocks that lower the path of expected policy rates lead to moderate increases in output and inflation, but Kim (2017) and Lakdawala (2019) find that these forward guidance shocks are contractionary, which they see as supporting the information signaling view of Nakamura and Steinsson (2018a).…”

“…An issue that affects the interpretation of the slope shock impulse response function is the extent to which the elements of slope policy revealed during an announcement convey Fed inside information about the economy, as opposed to information about the future path of policy (see for example Campbell et al (2012), Nakamura and Steinsson (2018a, b), Kim (2017), and Lakdawala ( 2019)).…”

The quest for economic stability: a study on Swedish stabilisation policies 1873–2019

“…While no method is without its weaknesses, the SVAR model approach is the most commonly used with extensive applications in in economic history (see for example, Perry & Vernengo, 2013;Rousseau & Stroup, 2011;Sabaté, Gadea, & Escario, 2006;Shibamoto & Shizume, 2014), economics (see for example, Auerbach & Gorodnichenko, 2012;Bakaert, Hoerova, & Duca, 2013;Cheng & Yang, 2020;Christiano et al, 1999), and among policy organisations such as OECD and central banks (see for example Jensen & Pedersen, 2019;Kim, 2017;Villani & Varne, 2003). The use of the high-frequency method is of course limited in economic history where the access to minuteby-minute trading data is rare.…”

“…Data source GDP 1873-1950Schön and Krantz (2015), 1951 Statistics Sweden. Current account balance in relation to GDP 1873-2016Jordá, Schularick, and Taylor (2017), 2017Statistics Sweden. Exchange rate SEK vs. USD 1873-1914Lobell (2010), 1915-2008Bohlin (2010 Appendix B: Estimation results and impulse response functions…”

The Long-term Rate and Interest Rate Volatility in Monetary Policy Transmission

“…As to forward guidance, a change in communication styles is generally correlated with a positive volatility surprise Lakdawala (2016). andKim (2017) both find that forward guidance shocks are contractionary. The public may perceive more variation in future monetary policy shocks due to shifts in communication approaches.…”