Working Paper: CEPR ID: DP14830
Authors: Ricardo Caballero; Alp Simsek
Abstract: We build a model in which the Fed and the market disagree about future aggregate demand. The market anticipates monetary policy "mistakes," which affect current demand and induce the Fed to partially accommodate the market's view. The Fed expects to implement its view gradually. Announcements that reveal an unexpected change in the Fed's belief provide a microfoundation for monetary policy shocks. Tantrum shocks arise when the market misinterprets the Fed's belief and overreacts to its announcement. Uncertainty about tantrums motivates further gradualism and communication. Finally, disagreements affect the market's expected inflation and induce a policy trade-off similar to "cost-push" shocks.
Keywords: Monetary Policy and Shocks; Belief Disagreements; Interest Rates; The Fed's Greenbook Projections and the Dot Plot; Fed Belief Surprises; Tantrum Shocks; Communication; Gradualism; Forward Guidance; Cost-Push Shocks
JEL Codes: E00; E12; E21; E32; E43; E44; G11; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| fed belief disagreements about future aggregate demand (E19) | distinct interest rate predictions (E43) |
| fed's optimal interest rate policy (E52) | influenced by its expectation of the market's view (D84) |
| fed belief surprises (G41) | affect market expectations (D84) |
| tantrum shocks (E32) | lead to an overreaction in forward rates (E43) |
| tantrum shocks (E32) | cause the fed to miss its output gap targets (E52) |
| fed's gradualism in policy adjustments (E52) | influenced by belief disagreements (D80) |
| fed's perception (E52) | market reactions (G10) |