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

Armour, Jamie; Engert, Walter; Fung, Ben

doi:10.2139/ssrn.56181

Cited by 19 publications

(9 citation statements)

References 18 publications

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“…There are a few papers for Canada on identifying the effects of monetary policy with VARs. Armour et al (1996) use a standard VAR with the recursive assumptionà la Christiano et al (1996Christiano et al ( , 1999 and find small effects on output and prices (peak of -0.1 per cent).…”

Section: C5 Comparison With Wider Literaturementioning

confidence: 99%

Changes in monetary regimes and the identification of monetary policy shocks: Narrative evidence from Canada

Champagne

Sekkel

2018

Journal of Monetary Economics

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Quantifying the effects of monetary policy is challenging and has generated a vast literature in empirical macroeconomics. Much of this literature uses vector autoregressions (VARs), identified with different approaches, and finds that the effects of monetary policy for the U.S. are relatively modest, with peak decline estimates ranging between 0.3 and 1 per cent for output following a 100-basis-point monetary innovation. However, Romer and Romer (2004; R&R henceforth) find much larger effects of U.S. monetary policy shocks using narrative methods. This strategy uses historical records to construct a series of intended interest rate changes at meetings of the Federal Open Market Committee (FOMC) and then isolate the innovations to these interest rate changes that are orthogonal to the Federal Reserve's information set. A 100-basis-point shock from the R&R shock series translates into output and price level peak declines larger than 4 per cent. The study by Cloyne and Hurtgen (2016) extends the narrative approach to the U.K. and is, to our knowledge, the only one applying narrative methods to a country other than the U.S. Another important body of literature in monetary economics has documented important shifts in the conduct of monetary policy in the U.S. and abroad. Some prominent papers, such as Clarida et al. (2000), document that U.S. monetary policy has become more responsive to expected inflation after the Volcker disinflation. There is also evidence that monetary policy rules in small open economies have also changed significantly. For example, Alstadheim et al. (2013) show that the central banks of the U.K., Sweden and Canada shifted away from responding to exchange rate movements around the 1990s, when these countries implemented inflation-targeting (IT) regimes. Our paper builds on these two strands of literature and applies the narrative approach to Canada, providing new evidence on the macroeconomic effects of monetary policy and highlighting the importance of changes in the conduct of systematic monetary policy. We use historical documents to construct a series of intended changes in the target policy interest rate along with a novel database of real-time data and forecasts assembled from the Bank of Canada's staff economic projections from 1974 to 2015, to isolate the innovations to the intended policy changes that are orthogonal to the policymakers' information set. We find that following a 100-basis-point monetary policy shock, real monthly GDP has a peak decline of 1.0 per cent about 18 to 24 months after the shock and is less than 0.5 per cent lower after three years, while the price level (consumer price index) response is weaker and takes longer to materialize, falling by 0.4 per cent after three years. We show that it is crucial for these results to depart from R&R in two important ways: (i) by controlling for U.S. interest rates as well as the USD/CAD exchange rate in the policy-makers' information set, and (ii) by accounting for the structural break in the conduct of monetary policy caused ...

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Section: C5 Comparison With Wider Literaturementioning

confidence: 99%

Changes in monetary regimes and the identification of monetary policy shocks: Narrative evidence from Canada

Champagne

Sekkel

2018

Journal of Monetary Economics

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“…4 Armour et al (1996) find that innovations in the overnight rate, derived using a Choleski decomposition, were consistent with intended policy actions as described in the Bank of Canada's Annual Reports since the early 1960s.…”

Section: Data and Preliminary Specificationmentioning

confidence: 55%

Macroeconomic Switching Regimes and Monetary Policy in Canada

Lange

2017

AEF

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This study examines the behaviour of monetary policy in Canada over the last 40 years using a Markov-switching VAR model of the macroeconomy. The Markov-switching estimates capture three continuous regimes that are interpreted as the 'surprise' regime from 1972Q1 to 1982Q2, the 'recovery' regime from 1982Q3 to 1991Q3 and the 'target' regime from 1991Q4 to 2014Q4. Monetary policy multipliers for the output gap are greater than one for all three regimes, suggesting that the central bank does not accommodate any expected changes in inflation over the long-run due to the domestic relationship between the output gap and future inflation. The long-run multipliers for inflation are equal to one in the surprise and recovery regimes, indicating that monetary policy also responds to offset inflation shocks. Overall, the policy multipliers and impulse response functions indicate a proactive central bank that responds systematically to movements in the output gap in order to control expected future inflation and to inflation surprises in the three regimes. The regime-dependent behaviour of monetary policy indicates a central bank pursuing an implicit form of inflation targeting as a means of achieving a nominal anchor for policy. The implicit inflation targets are consistent with historical episodes of inflation in Canada over the past 40 years. JEL Classification: E44, E52

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“…3 Data for the estimations were retrieved from the OECD database for "Main Economic Indicators" (2010) at https://doi.org/10.1787/data-00052-en and available on Federal Reserve Economic Data (FRED). 4 Armour et al (1996) find that innovations in the overnight rate, derived using a Choleski decomposition, were consistent with intended policy actions as described in the Bank of Canada's Annual Reports since the early-1960s. 5 Hodrick and Prescott motivated their choice of = 1600 based on the prior belief that a large change in the cyclical component within a quarter would be around 5 per cent, whereas a large change in the trend component would be around (1/8) per cent, suggesting a choice of = ⁄ = ( ) ( ) ⁄ = , where is the variance of the cyclical component and is the variance of the trend component.…”

Section: Data and Preliminary Specificationmentioning

confidence: 56%

The Monetary Transmission Mechanism in Canada: A Time-Varying Vector Autoregression with Stochastic Volatility

Lange

2018

AEF

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This study uses the state-space representation of a time-varying vector autoregression with stochastic volatility (TVP-VAR-SV) to study monetary policy and private sector behaviour in Canada. The main results indicate that both shock variances and autoregressive coefficients of the VAR have evolved systematically over time. The time-varying coefficients of the systematic component of the VAR suggest that monetary policy has become more proactive and less reactive regarding inflation since the early-1990s, which coincides with the adoption of explicit inflation targets. Monetary policy is now able to focus mainly on movements in the output gap to prevent future increases in inflation. The coefficients on the policy rate in both the output gap and inflation equations suggest that the private sector and therefore the transmission mechanism have become more sensitive to monetary policy responses. On the other hand, the coefficients on the output gap in the equations for both inflation and the policy rate have been relatively stable over this period, consistent with view that monetary policy remains more forward-looking regarding inflation than being reactive to inflation surprises as in the past.

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

Cited by 19 publications

References 18 publications

Changes in monetary regimes and the identification of monetary policy shocks: Narrative evidence from Canada

Changes in monetary regimes and the identification of monetary policy shocks: Narrative evidence from Canada

Macroeconomic Switching Regimes and Monetary Policy in Canada

The Monetary Transmission Mechanism in Canada: A Time-Varying Vector Autoregression with Stochastic Volatility

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