Inflation Measured Every Day Keeps Adverse Responses Away: Temporal Aggregation and Monetary Policy Transmission
Margaret M. Jacobson, Christian Matthes, and Todd B. Walker
Abstract: Using daily inflation data from the Billion Prices Project [Cavallo and Rigobon (2016)], we show how temporal aggregation biases estimates of monetary policy transmission. We argue that the information mismatch between private agents and the econometrician —the source of temporal aggregation bias —is equally important as the more studied mismatch between private agents and the central bank (the “Fed information effect”). We find that the adverse response of daily inflation to high-frequency monetary policy shocks is short-lived, if present at all, in impulse responses from both local projections and an unobserved components model of inflation dynamics. To reconcile how one can obtain a sizable adverse response with monthly or quarterly data when only a limited adverse response exists at a higher frequency, we appeal to a simple monetary policy model and show how temporal aggregation bias can exacerbate initial impulse response functions. Because our modeling results are generic and macroeconomic indicators are published with a lag, we argue that temporal aggregation bias will be a key feature of the nascent field of high-frequency macroeconomics.
Introduction: This paper revisits a fundamental question of monetary economics: What is the transmission of monetary policy to the economy? Empirical work often finds that macroeconomic variables respond to monetary policy shocks in the opposite direction of what standard theory predicts. Researchers trace these adverse responses to information issues, with existing solutions consisting of either adding more information [Sims (1992)] or emphasizing information mismatches between central banks and private sector agents as a “Fed information effect” [Campbell et al. (2012) and Nakamura and Steinsson(2018a)].
We propose temporal aggregation bias as a new information-based explanation for the adverse transmission of monetary policy shocks. When using the daily CPI from the Billion Prices Project [Cavallo and Rigobon (2016)] as a temporally disaggregated macroeconomic indicator, we find that the adverse response of inflation is short-lived, if it is present at all. We argue that existing work on monetary policy transmission finds an adverse response because of the frequency mismatch between the information sets of the econometrician and private agents. A temporally disaggregated measure of inflation overcomes this mismatch by better aligning the frequencies of shocks and dependent variables.