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Empirical and Theoretical Aspects of Monetary Policy

Paper Session

Sunday, Jan. 7, 2018 8:00 AM - 10:00 AM

Loews Philadelphia, Parlor 1
Hosted By: Society for Nonlinear Dynamics and Econometrics
  • Chair: Kevin J. Lansing, Federal Reserve Bank of San Francisco

A Shadow Rate New Keynesian Model

Jing Cynthia Wu
University of Chicago
Ji Zhang
Tsinghua University


We propose a New Keynesian model with the shadow rate, which is the federal funds rate during normal times. At the zero lower bound, we establish empirically the negative shadow rate summarizes unconventional monetary policy with its resemblance to private interest rates, the Fed's balance sheet, and Taylor rule. Theoretically, we formalize our shadow rate New Keynesian model with QE and lending facilities. Our model generates the data-consistent result: a negative supply shock is always contractionary. It also salvages the New Keynesian model from the zero lower bound induced
structural break.

The Time-varying Effects of Conventional and Unconventional Monetary Policy: Results From a New Identification Procedure

Barbara Rossi
ICREA-Pompeu Fabra University, Barcelona GSE, and CREI
Atsushi Inoue
Vanderbilt University


We propose a new procedure to identify shocks. The novelty in our procedure is that it identifies shocks as exogenous shifts in a function. We apply our new identification procedure to identify unconventional monetary policy shocks as shifts in the whole term structure of government yields in a narrow window of time around the unconventional monetary policy announcement. Our identification sheds new light on the effects of monetary policy shocks, both in conventional and unconventional periods, and shows that conventional identification procedures may miss important effects. We find that, except for two episodes, unconventional monetary policy has similar effects to conventional monetary policy, namely both output growth and consumption have a hump-shaped response, peaking around one year to one year and a half after the shock, and disappearing after one to two years. The new procedure has the potential to identify monetary policy shocks during both conventional and unconventional monetary policy periods in a unified manner.

Output Gap, Monetary Policy Trade-offs and Financial Frictions

Francesco Furlanetto
Norges Bank
Paolo Gelain
Norges Bank
Marzie Taheri Sanjani
International Monetary Fund


This paper investigates how the presence of financial frictions and financial shocks changes the definition and the estimated dynamics of the output gap in a New Keynesian model. Financial shocks absorb explanatory power from efficient labor supply shocks, thus changing radically the dynamics of the economy's efficient frontier. Despite their large impact on the output gap, financial factors affect the monetary policy trade-offs only to some extent. Nominal stabilization can be achieved at the cost of limited (but non-negligible) fluctuations in real economic activity. Finally, we discuss an alternative measure of the output gap (in deviation from the optimal equilibrium) that is a better measure of imbalances in the economy than the conventional output gap.

Estimating and Accounting for the Output Gap With Large Bayesian Vector Autoregressions

James Morley
University of Sydney
Benjamin Wong
Reserve Bank of New Zealand


We demonstrate how Bayesian shrinkage can address problems with utilizing
large information sets to calculate trend and cycle via a multivariate Beveridge-Nelson (BN) decomposition. We illustrate our approach by estimating the U.S. output gap with large Bayesian vector autoregressions that include up to 138 variables. Because the BN trend and cycle are linear functions of historical forecast errors, we are also able to account for the estimated output gap in terms of different sources of information, as well as particular underlying structural shocks given identification restrictions. Our empirical analysis suggests that, in addition to output
growth, the unemployment rate, CPI inflation, and, to a lesser extent, housing starts, consumption, stock prices, real M1, and the federal funds rate are important conditioning variables for estimating the U.S. output gap, with estimates largely robust to incorporating additional variables. Using standard identification restrictions, we find that the role of monetary policy shocks in driving the output gap is small, while oil price shocks explain about 10% of the variance over different horizons.
Alex Richter
Federal Reserve Bank of Dallas
Christiane Baumeister
University of Notre Dame
Christopher Otrok
University of Missouri
Hilde Bjørnland
BI Norwegian Business School
JEL Classifications
  • E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit
  • E3 - Prices, Business Fluctuations, and Cycles