Working Paper: NBER ID: w20224
Authors: Mark Gertler; Peter Karadi
Abstract: We provide evidence on the nature of the monetary transmission mechanism. To identify policy shocks in a setting with both economic and financial variables, we combine traditional monetary vector autoregression (VAR) analysis with high frequency identification (HFI) of monetary policy shocks. We first show that the shocks identified using HFI surprises as external instruments produce responses in output and inflation consistent with both textbook theory and conventional monetary VAR analysis. We also find, however, that monetary policy surprises typically produce "modest movements" in short rates that lead to "large" movements in credit costs and economic activity. The large movements in credit costs are mainly due to the reaction of both term premia and credit spreads that are typically absent from the standard model of monetary policy transmission. Finally, we show that forward guidance is important to the overall strength of the transmission mechanism.
Keywords: Monetary Policy; Credit Costs; Economic Activity
JEL Codes: E3; E4; E5
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Monetary policy surprises (E39) | Modest movements in short rates (E43) |
| Modest movements in short rates (E43) | Large movements in credit costs (G21) |
| Modest movements in short rates (E43) | Economic activity (E29) |
| Unanticipated monetary tightening (E49) | Significant drop in output (E23) |
| Unanticipated monetary tightening (E49) | Modest drop in the price level (E31) |
| Unanticipated monetary tightening (E49) | Increase in real credit costs (G21) |
| Forward guidance (Y20) | Overall strength of the monetary policy transmission mechanism (E52) |
| Monetary policy surprise (E49) | Economic activity (E29) |