Uncertainty and monetary policy in the US: A journey into nonlinear territory

Abstract

This paper estimates a nonlinear vector autoregression (VAR) model to assess whether the real effects of monetary policy shocks depend on the level of uncertainty. Crucially, uncertainty is modeled endogenously in the VAR, thus allowing to take account of two unexplored channels of monetary policy transmission working through uncertainty direct reaction and uncertainty mean reversion. We find that monetary policy shocks are about 50-75% more powerful during tranquil times than during firm-and macro-level uncertain times. Failing to account for endogenous uncertainty would bias responses and imply twice more effective monetary policy during tranquil times, mainly because of the non-consideration of uncertainty mean reversion.

Uncertainty and monetary policy in good and bad times: A replication of the vector autoregressive investigation by Bloom (2009)

“…Finally, our paper shows that systematic monetary policy is less effective as a stabilization tool during a recession. This last analysis complements the ones on the effects of monetary policy shocks in high/low uncertainty regimes by Castelnuovo and Pellegrino (2018) and Pellegrino (2018Pellegrino ( , 2021 and those on the "risk management" approach undertaken by the Federal Reserve when tackling uncertainty shocks (Caggiano et al, 2018;Evans et al, 2015).…”

“…CPI, consumer price index is the standardized zero mean-unit standard deviation backward-looking moving average of the yearly growth rate of industrial production. The smoothness parameter 𝛾 is notoriously difficult to estimate because of well-known identification issues (see the discussion in Teräsvirta et al, 2010). We calibrate 𝛾 = 1.8 to match the frequency of the US recessions, which amounts to 14% in our sample.…”

“…The vector of endogenous variables X t is modeled with the following STVAR (for a detailed presentation, see Teräsvirta et al, 2010):…”

Disagreement on expectations: firms versus consumers

“…On the other hand, it should be noted that the uncertainty measure used in the study is based on an indicator of geometric discrepancy, and therefore is based on the disagreement between the agents. As pointed out by Pellegrino ( 2021 ), the fact that uncertainty measures are not fully embedded in the econometric models at the estimation stage might cause measurement errors in the regressors and lead to an endogeneity bias. Consequently, the results that have been obtained can also be partially explained by the use of indicators of disagreement as a proxy for economic uncertainty.…”

Covid-19 Uncertainty and Monetary Policy Responses: Evidence From Emerging Market Economies

“…The evidence also suggests that the monetary authorities aggressively react under uncertainty (Giannoni, 2002;Sonderstrom, 2002). Similarly, the recent study by Pellegrino (2021) shows that accounting for uncertainty shocks would help important transmission channels and estimate the effects of an unexpected monetary stimulus in an accurate manner.…”