Thomas Drechsel | Macro Paper Warehouse

Identifying Monetary Policy Shocks: A Natural Language Approach

Thu, 01 Jan 2026 00:00:00 +0000

Research question and motivation: To study how monetary policy affects the economy, macroeconomists must isolate “shocks” — changes in interest rates that are not systematic responses to economic conditions. The paper proposes a new identification method that captures the Federal Reserve’s information set far more comprehensively than prior approaches, using the natural-language text of documents Fed staff prepare for FOMC meetings, not just numerical forecasts.

Method and data: The approach extends Romer and Romer (2004), who regress changes in the Federal Funds Rate (FFR) target on Greenbook forecasts and take the residual as the shock. The authors instead convert the text of FOMC documents into many “aspect-based” sentiment time series and predict the FFR change with both these sentiments and an expanded forecast set. They process 772 PDF files for 276 meetings (630 files for 210 meetings before the zero lower bound), covering Greenbook 1/2, Tealbook A, Redbook, and Beigebook documents, starting October 5, 1982 (when the Fed began targeting the FFR per Thornton 2006). Most documents are released with a 5-year lag, so the latest is from end-2016. They extract the most frequently mentioned economic terms, yielding 296 single/multi-word concepts (e.g., “inflation,” “economic activity”). For each concept they build a sentiment indicator by scoring positive (+1) and negative (-1) words within a 10-word window, using an augmented Loughran-McDonald (2011) dictionary of 2,882 classified words. The empirical model (equation 3) includes 132 forecast series, 296 sentiment indicators with 4 lags, and quadratic terms — 3,226 regressors total — far exceeding the 210 FOMC-meeting observations over October 1982 to October 2008. They estimate it with a ridge regression, choosing the penalty by 10-fold cross-validation; the shock is the residual.

Income Inequality and Job Creation

The paper establishes a causal link from rising top income shares to reduced net job creation at small firms, working through a bank funding channel rooted in non-homothetic household portfolio allocation: because high-income households hold a smaller fraction of financial wealth in bank deposits (less than one-fifth for the top decile versus two-thirds for the bottom quintile, per the Survey of Consumer Finance), a redistribution of income toward top earners shifts aggregate saving away from deposits toward stocks and bonds. Banks must raise deposit rates to retain funding, which passes through to loan rates; since small, informationally-opaque firms depend disproportionately on bank credit while large firms have direct capital-market access, higher loan rates compress small firms’ net job creation relative to large firms. Using U.S. state-level panel data from 1981 to 2015, a shift-share instrumental variable, and a quantitative general equilibrium model, the paper documents this channel and finds it accounts for 13% of the 4.97 percentage-point rise in large-firm employment share and between 7.5% and 15% of the decline in the labor share since 1980.

Political Pressure on the Fed

This paper combines a hand-collected archival data set of over 800 personal interactions between U.S. Presidents and Federal Reserve officials from 1933 to 2016 with a narrative structural VAR to identify shocks to political pressure on the Fed and quantify their macroeconomic effects. The identification strategy exploits the well-documented Nixon-Burns episode of 1971—corroborated by Nixon Tapes recordings and Burns’s personal diary—as a narrative restriction that the spike in personal interactions that year was driven primarily by a political pressure shock rather than by economic conditions. Political pressure shocks are found to (i) increase inflation strongly and persistently, (ii) lead to statistically weak negative effects on activity, (iii) contribute to inflationary episodes outside the Nixon era, and (iv) transmit differently from standard expansionary monetary policy shocks because political pressure can be publicly observed, generating a stronger direct effect on inflation expectations. Quantitatively, increasing political pressure by half as much as Nixon, sustained for six months, is estimated to raise the price level by more than 8%.

The long and variable lags of monetary policy: Evidence from disaggregated price indices

This 2024 Journal of Monetary Economics paper by S. Borağan Aruoba and Thomas Drechsel asks why the aggregate U.S. price level responds to monetary policy only after a long delay, and locates the answer in the cross-section of price categories rather than in uniform price stickiness. Using monthly Personal Consumption Expenditures Price Index (PCEPI) data disaggregated into as many as 136 subcomponents at five levels of aggregation (1982-2008, a sample chosen to exclude the zero lower bound and COVID episodes), the authors estimate a Jordà-style local projection for each individual price series against an external, non-market-based monetary policy shock constructed in a companion paper (Aruoba and Drechsel 2023) from natural-language processing of Federal Reserve Greenbook/Tealbook documents, following the Romer-Romer (2004) narrative approach. Because the individual-series impulse responses are estimated separately, the authors re-aggregate them into an implied aggregate PCEPI response using a weighted sum of the disaggregated coefficients, and correct the standard error of that re-aggregated response for cross-sectional correlation across price series with a seemingly-unrelated-regressions/feasible-generalized-least-squares (SUR-FGLS) procedure — showing that because price movements are mostly positively correlated across categories, naive standard errors that ignore this covariance are too small and would spuriously reject a zero response earlier than the correct SUR-corrected bands do. The headline empirical result is that, following a 100-basis-point monetary contraction, the aggregate (and core) PCEPI shows no statistically significant decline for roughly 43 months, only turning significantly negative after that point and reaching a peak reduction of roughly 4% (headline) and roughly 2.5% (core) around 54 months — consistent with Christiano, Eichenbaum, and Evans’s (1999) finding of a multi-year delay before the aggregate price level falls significantly. Critically, the paper shows this aggregate flatness does not reflect uniform stickiness: at the finest (136-series) level of disaggregation, roughly half of all price series show a significantly positive response to a monetary tightening at some horizon, and a substantial share never turn significantly negative at all, so the eventual aggregate decline emerges only once enough individual series’ responses turn negative to outweigh the persistently positive ones — a pattern the authors argue is inconsistent with standard Calvo or menu-cost stickiness models (which predict faster responses for more frequently adjusting prices, a relationship the data does not show) and better rationalized by a heterogeneous cost-channel/demand-substitution mechanism in which a monetary tightening acts as a demand shock for some sectors but raises costs (and hence prices) for financially constrained sectors in the short run. The authors also show that re-aggregating with 1959 versus 2023 expenditure shares yields similar aggregate timing and magnitude, indicating that decades of structural change in consumption patterns have not accelerated the aggregate lag — leading them to connect the finding explicitly to Friedman’s (1960, 1961) claim that monetary policy operates with “long and variable lags,” here documented in the cross-section of prices as well as in the aggregate time series.