1. 1. Monetary Policy Uncertainty: Does it justify requiring the Fed follow a Taylor rule? Jacques Alcabes, ngelo Gutirrez, Patrick Mayer & Hugo Kaminski Barcelona Graduate School of Economics June 2015
2. 2. Motivation: Monetary Policy Uncertainty and the FRATA Central banks role in failing to prevent or mitigate global crisis Federal Reserve Accountability and Transparency Act introduced in 2014: The Fed would announce a policy rule and set the policy rate according to this rule Any deviations from this rule or changes to it would require testimony to Congress Key intention: reduce the uncertainty related to central bank policy actions
3. 3. Intense debate among economists...
4. 4. Our contribution Methodology for constructing measures of monetary policy uncertainty from monetary policy shocks previously identied in the literature Index of monetary policy uncertainty based on the unpredictability of the non-systemic movements of the interest rate Use these measures to estimate the impact of monetary policy uncertainty shocks to the economy as well as its contribution to business cycles uctuations
5. 5. Measuring Monetary Policy Shocks Monetary policy shocks are usually interpreted in the literature as deviations from a Taylor rule: it = i + y yt + t + i t Signicant body of research dealing with the estimation of i t and its impact on the economy: Narrative measures: (e.g., Romer & Romer (2004)) Structural VAR estimates: (e.g., Sims & Zha (2006), Jurado et al. (2015)) Fancy stuff: Gertler & Karadi (2015)
6. 6. Monetary Policy Shocks Romer & Romer (2004) - Narrative Measure Sims & Zha (2006) - Time-Varying Parameter VAR 1960M2 1964M4 1968M6 1972M8 1976M10 1980M12 1985M2 1989M4 1993M6 1997M8 2001M10 2005M12 2010M2 10 5 0 5 1960M2 1964M4 1968M6 1972M8 1976M10 1980M12 1985M2 1989M4 1993M6 1997M8 2001M10 2005M12 2010M2 50 40 30 20 10 0 10 20 30 Gertler & Karadi (2015) - Proxy SVAR + HFI Jurado, Ludvigson & Ng (2015) - Monetary SVAR 1960M2 1964M4 1968M6 1972M8 1976M10 1980M12 1985M2 1989M4 1993M6 1997M8 2001M10 2005M12 2010M2 0.5 0.4 0.3 0.2 0.1 0 0.1 0.2 1960M2 1964M4 1968M6 1972M8 1976M10 1980M12 1985M2 1989M4 1993M6 1997M8 2001M10 2005M12 2010M2 10 8 6 4 2 0 2 4 6 8
7. 7. Monetary Policy Shocks: Rolling 2-year Standard Deviations Romer & Romer (2004) Sims & Zha (2006) 1960M2 1964M4 1968M6 1972M8 1976M10 1980M12 1985M2 1989M4 1993M6 1997M8 2001M10 2005M12 2010M2 0 0.5 1 1.5 2 2.5 3 1960M2 1964M4 1968M6 1972M8 1976M10 1980M12 1985M2 1989M4 1993M6 1997M8 2001M10 2005M12 2010M2 0 5 10 15 Gertler & Karadi (2015) Jurado, Ludvigson & Ng (2015) 1960M2 1964M4 1968M6 1972M8 1976M10 1980M12 1985M2 1989M4 1993M6 1997M8 2001M10 2005M12 2010M2 0 0.01 0.02 0.03 0.04 0.05 0.06 0.07 0.08 0.09 0.1 1960M2 1964M4 1968M6 1972M8 1976M10 1980M12 1985M2 1989M4 1993M6 1997M8 2001M10 2005M12 2010M2 0 0.5 1 1.5 2 2.5 3 3.5
8. 8. Monetary Policy Uncertainty We assume that i t has stochastic volatility of the form: t = t t log 2 t = (1 ) log 2 + log 2 t1 + t ; t iid (0, 1) t iid 0, 2 We follow Harvey (1994) and compute the Quasi-Maximum Likelihood estimators of , 2 and 2 using the Kalman Filter and an approximation to the measurement equation. Then, we compute minimum MSE linear estimators t and t using the Kalman Smoother.
9. 9. Estimated Monetary Policy Uncertainty: Sims & Zha (2006) 1960M3 1963M7 1966M11 1970M3 1973M7 1976M11 1980M3 1983M7 1986M11 1990M3 1993M7 1996M11 2000M3 3 2 1 0 1 2 3 4 5 6
10. 10. Dynamic Impact of Monetary Policy on the Economy Following Jorda (2005), we compute the impulse-response function of these shocks on several variables using local linear projections: IR (t, h, dt ) =E (yt+h|vt = dt ; Xt ) E (yt+h|vt = 0; Xt ) = dt for h = 0, 1, . . . , H; dt { t , t }. These projections can be immediately computed from sequential OLS regressions of yt+h on dt and additional controls.
11. 11. IRF Monetary Policy Uncertainty Shock: Sims & Zha (2006) Industrial Production (Logs) Employment (Logs) 5 10 15 20 25 30 35 40 45 50 55 60 0.4 0.3 0.2 0.1 0 0.1 5 10 15 20 25 30 35 40 45 50 55 60 0.14 0.12 0.1 0.08 0.06 0.04 0.02 0 0.02 0.04 0.06 S&P 500 Index (Logs) Producer Price Index (Logs) 5 10 15 20 25 30 35 40 45 50 55 60 2 1.5 1 0.5 0 0.5 5 10 15 20 25 30 35 40 45 50 55 60 0.1 0.05 0 0.05 0.1 0.15 0.2 0.25 0.3 0.35 0.4
12. 12. Level Shock t vs. Variance Shock t Industrial Production (Logs) Employment (Logs) 5 10 15 20 25 30 35 40 45 50 55 60 0.25 0.2 0.15 0.1 0.05 0 0.05 0.1 5 10 15 20 25 30 35 40 45 50 55 60 0.1 0.08 0.06 0.04 0.02 0 0.02 0.04 0.06 S&P 500 Index (Logs) Producer Price Index (Logs) 5 10 15 20 25 30 35 40 45 50 55 60 1 0.8 0.6 0.4 0.2 0 0.2 0.4 0.6 5 10 15 20 25 30 35 40 45 50 55 60 0.2 0.15 0.1 0.05 0 0.05 0.1 0.15 0.2 0.25
13. 13. Measuring Monetary Policy Uncertainty Following Jurado, Ludvigson & Ng (2015), we compute the conditional volatility of the purely unforecastable component of the interest rate Ui t = E (it+1 E [it+1|It ])2 |It We call this a measure of interest rate uncertainty. We compute a monetary policy uncertainty index as the part of the interest rate uncertainty that is not related to macro aggregate uncertainty.
14. 14. Monetary Policy Uncertainty Index 0.00 0.20 0.40 0.60 0.80 1.00 1.20 -1.00 -0.50 0.00 0.50 1.00 1.50 1/1963 8/1964 3/1966 10/1967 5/1969 12/1970 7/1972 2/1974 9/1975 4/1977 11/1978 6/1980 1/1982 8/1983 3/1985 10/1986 5/1988 12/1989 7/1991 2/1993 9/1994 4/1996 11/1997 6/1999 1/2001 8/2002 3/2004 10/2005 5/2007 12/2008 7/2010 2/2012 9/2013 Interest Rate Uncertainty Monetary Policy Uncertainty Macroeconomic Uncertainty Index (Right Axis)
15. 15. Monetary Policy Uncertainty Index A B C D E -0.8 -0.6 -0.4 -0.2 0 0.2 0.4 0.6 0.8 1 1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 Fall of Continental Illinois, one of the largest banks in the U.S. and a case of a "too big too fail" rescue policy The start of Ben Bernanke as new Chairman of the Fed, preceding the 2008 financial crisis Change in Fed leadership replacing Arthur Burns with G. William Miller. Replaced a year later by Volcker Start of Arthur Burns as new Fed Chairman
16. 16. Forecast Error Variance Decomposition Variable Shock Horizon IPI Employment PCE De S&P 500 Monetary Policy 6 2.11 0.80 2.24 1.21 Uncertainty 60 2.37 1.63 1.08 3.38 Aggregate Macro 6 3.39 2.90 1.42 8.39 Uncertainty 60 9.39 13.9 0.90 12.3 Federal Funds 6 2.78 2.34 0.47 2.42 Rate 60 23.3 36.1 18.1 1.24
17. 17. Summary Monetary policy uncertainty has statistically signicant effects that resemble the effects of a traditional monetary policy shock but: More delayed effect and stronger impact on nancial variables. Monetary policy uncertainty shocks are not a major contributor to business cycle uctuations: They explain less than 4% of the forecast error variance of Industrial Production, employment and ination after a year . This evidence suggests that the potential benets of requiring the Fed to follow a policy rule are small if the main purpose is merely to reduce policy uncertainty.
18. 18. Thank You!
19. 19. Appendix: Variables of Estimated VAR Yt = log (real IP) log (employment) log (real consumption) log (PCE deator) log (real new orders) log (real wage) hours federal funds rate log (S&P 500 Index) log (M2) Monetary Policy Index Macro Uncertainty
20. 20. Appendix: Baseline Specication for the LP Yt+h =hdt + p i=1 ihYti + q i=1 ihiti + q i=1 ih2 ti + t For h = 0, 1, . . . 60. Newey-West estimator for the standard errors, with bandwidth equal to h. p = q = 12 in baseline scenario.
21. 21. Appendix: IRF MPU Shock Romer & Romer (2004) Industrial Production (Logs) Employment (Logs) 5 10 15 20 25 30 35 40 45 50 55 60 0.4 0.3 0.2 0.1 0 0.1 0.2 0.3 0.4 0.5 5 10 15 20 25 30 35 40 45 50 55 60 0.2 0.15 0.1 0.05 0 0.05 0.1 0.15 0.2 0.25 S&P 500 Index (Logs) Producer Price Index (Logs) 5 10 15 20 25 30 35 40 45 50 55 60 1.5 1 0.5 0 0.5 1 5 10 15 20 25 30 35 40 45 50 55 60 0.2 0.1 0 0.1 0.2 0.3
22. 22. Appendix: IRF MPU Shock Gertler & Karadi (2015) Industrial Production (Logs) Employment (Logs) 5 10 15 20 25 30 35 40 45 50 55 60 0.25 0.2 0.15 0.1 0.05 0 0.05 0.1 0.15 0.2 5 10 15 20 25 30 35 40 45 50 55 60 0.08 0.06 0.04 0.02 0 0.02 0.04 0.06 0.08 S&P 500 Index (Logs) Producer Price Index (Logs) 5 10 15 20 25 30 35 40 45 50 55 60 1 0.5 0 0.5 5 10 15 20 25 30 35 40 45 50 55 60 0.12 0.1 0.08 0.06 0.04 0.02 0 0.02 0.04 0.06 0.08
23. 23. Appendix: IRF MPU Shock JLN (2015) Industrial Production (Logs) Employment (Logs) 5 10 15 20 25 30 35 40 45 50 55 60 0.3 0.25 0.2 0.15 0.1 0.05 0 0.05 0.1 0.15 5 10 15 20 25 30 35 40 45 50 55 60 0.12 0.1 0.08 0.06 0.04 0.02 0 0.02 S&P 500 Index (Logs) Producer Price Index (Logs) 5 10 15 20 25 30 35 40 45 50 55 60 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0 5 10 15 20 25 30 35 40 45 50 55 60 0.1 0.05 0 0.05 0.1 0.15 0.2 0.25 0.3 0.35
24. 24. Appendix: IRF MPU Shock (36 lags) Romer & Romer (2004) Industrial Production (Logs) Employment (Logs) 5 10 15 20 25 30 35 40 45 50 55 60 0.25 0.2 0.15 0.1 0.05 0 0.05 0.1 0.15 5 10 15 20 25 30 35 40 45 50 55 60 0.08 0.06 0.04 0.02 0 0.02 0.04 0.06 0.08 0.1 S&P 500 Index (Logs) Producer Price Index (Logs) 5 10 15 20 25 30 35 40 45 50 55 60 1 0.5 0 0.5 1 5 10 15 20 25 30 35 40 45 50 55 60 0.15 0.1 0.05 0 0.05 0.1 0.15
25. 25. Appendix: IRF MPU Shock (36 lags) Sims & Zha (2006) Industrial Production (Logs) Employment (Logs) 5 10 15 20 25 30 35 40 45 50 55 60 0.6 0.5 0.4 0.3 0.2 0.1 0 0.1 0.2 0.3 5 10 15 20 25 30 35 40 45 50 55 60 0.25 0.2 0.15 0.1 0.05 0 0.05 0.1 S&P 500 Index (Logs) Producer Price Index (Logs) 5 10 15 20 25 30 35 40 45 50 55 60 4 3.5 3 2.5 2 1.5 1 0.5 0 0.5 1 5 10 15 20 25 30 35 40 45 50 55 60 0.2 0 0.2 0.4 0.6 0.8
26. 26. Appendix: IRF MPU Shock (36 lags) Gertler & Karadi (2015) Industrial Production (Logs) Employment (Logs) 5 10 15 20 25 30 35 40 45 50 55 60 0.3 0.2 0.1 0 0.1 0.2 0.3 0.4 5 10 15 20 25 30 35 40 45 50 55 60 0.06 0.04 0.02 0 0.02 0.04 0.06 0.08 S&P 500 Index (Logs) Producer Price Index (Logs) 5 10 15 20 25 30 35 40 45 50 55 60 1 0.5 0 0.5 1 5 10 15 20 25 30 35 40 45 50 55 60 0.15 0.1 0.05 0 0.05 0.1
27. 27. Appendix: IRF MPU Shock (36 lags) JLN (2015) Industrial Production (Logs) Employment (Logs) 5 10 15 20 25 30 35 40 45 50 55 60 0.3 0.25 0.2 0.15 0.1 0.05 0 0.05 0.1 0.15 5 10 15 20 25 30 35 40 45 50 55 60 0.14 0.12 0.1 0.08 0.06 0.04 0.02 0 0.02 S&P 500 Index (Logs) Producer Price Index (Logs) 5 10 15 20 25 30 35 40 45 50 55 60 1.2 1 0.8 0.6 0.4 0.2 0 5 10 15 20 25 30 35 40 45 50 55 60 0.1 0.05 0 0.05 0.1 0.15 0.2 0.25
28. 28. Appendix: IRF Level Monetary Policy Shock NKM Model Without Capital 5 10 15 3 2 1 0 ys_t 5 10 15 3 2 1 0 n_t 5 10 15 0.2 0.15 0.1 0.05 0 infl_t 5 10 15 0.5 0 0.5 1 r_t 5 10 15 0.5 0 0.5 1 i_t
29. 29. Appendix: IRF Variance Monetary Policy Shock NKM Model Without Capital 5 10 15 0.8 0.6 0.4 0.2 0 ys_t 5 10 15 0.8 0.6 0.4 0.2 0 n_t 5 10 15 0 0.05 0.1 0.15 0.2 infl_t 5 10 15 0.1 0.05 0 0.05 0.1 r_t 5 10 15 0 0.05 0.1 i_t 5 10 15 0 0.5 1 sigma_t