A New Approach to Measuring Economic Policy Shocks, with an Application to Conventional and Unconventional Monetary Policy

We propose a new approach to analyze economic shocks. Our new procedure identifies economic shocks as exogenous shifts in a function; hence, we call the "functional shocks". We show how to identify such shocks and how to trace their effects in the economy via VARs using a procedure that we call "VARs with functional shocks". Using our new procedure, we address the crucial question of studying the effects or monetary policy by identifying monetary policy shocks as shifts in the whole term structure of government bond yields in a narrow window of time around monetary policy announcements. Our identification sheds new light on the effects of monetary policy shocks, both in conventional and unconventional periods, and shows that traditional identification procedures may miss important effects. We find that, overall, unconventional monetary policy has similar effects to conventional expansionary monetary policy, leading to an increase in both output growth and inflation; the response is hump-shaped; peaking around one year to one year and a half after the shock. The new procedure has the advantage of identifying monetary policy shocks during both conventional and unconventional monetary policy periods in a unified manner and can be applied more generally to other economic shocks.