Deconstructing Monetary Policy Surprises—The Role of Information Shocks

This 2020 American Economic Journal: Macroeconomics paper by Marek Jarociński and Peter Karadi argues that conventional high-frequency-identified monetary policy surprises conflate two economically distinct shocks — a genuine monetary policy shock and a “central bank information shock” — and shows that separating them substantially changes conclusions about how powerfully monetary policy affects the economy. The key identifying insight is that a pure monetary policy tightening should raise interest rates while lowering stock prices (the standard asset-pricing prediction), whereas a central bank information shock — in which the central bank’s own announcement conveys good news about the economic outlook that partly offsets a simultaneous tightening — should raise both; using a Bayesian structural VAR combining high-frequency surprises (three-month fed funds futures and S&P 500 changes around 240 FOMC announcements, 1990-2016) with sign restrictions to disentangle the two, the authors find that around one-third of FOMC announcements historically show this “wrong-signed” positive interest-rate/stock-price co-movement. The purified monetary policy shock produces a more persistent decline in output and prices and a rise in the excess bond premium, while the information shock raises both output and prices and lowers the excess bond premium — and because these two shocks move macro variables in opposite directions, the paper shows that the conventional (unpurified) high-frequency-identified shock, which implicitly attributes all surprises to monetary policy, systematically understates the true effectiveness of monetary policy and generates spuriously large and persistent interest-rate responses. Structurally estimating a New Keynesian model with financial frictions to match the two sets of impulse responses, the authors find the conventional (contaminated) shock requires implausibly extreme price stickiness and negligible financial frictions to fit the data — essentially reproducing Nakamura and Steinsson’s (2018) puzzle — whereas the purified monetary policy shock is consistent with more moderate, empirically plausible price stickiness and substantially larger financial frictions, leading the authors to conclude that failing to control for central bank information shocks can seriously distort inferences about the transmission mechanism, including the perceived importance of financial frictions.

Marek Jarociński | Macro Paper Warehouse

Deconstructing Monetary Policy Surprises—The Role of Information Shocks