Working Paper: NBER ID: w27313
Authors: Ricardo J. 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; Market Expectations; Aggregate Demand
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's beliefs (E58) | monetary policy (E52) |
| market's pessimism about demand (D12) | expected interest rates (E43) |
| expected interest rates (E43) | Fed's monetary policy (E52) |
| Fed's beliefs and market beliefs (E52) | Fed's optimal interest rate policy (E52) |
| tantrum shocks (E32) | Fed's policy decisions (E52) |
| tantrum shocks (E32) | output gaps (E23) |
| disagreements (D74) | expected inflation (E31) |