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Did the Fed Surprise the Markets in 2001? A Case Study for VARs with Sign Restrictions

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  • Harald Uhlig

Abstract

In 2001, the Fed has lowered interest rates in a series of cuts, starting from 6.5 per cent at the end of 2000 to 2.0 per cent by early November. This paper asks, whether the Federal Reserve Bank has been surprising the markets, taking as given the conventional view about the effect of monetary policy shocks. New econometric techniques turn out to be particularly suitable for answering this question: this paper can be viewed as a showcase and case study for their application. In order to concentrate on the Greenspan period, a vector autoregression is fitted to US data, starting in 1986 and ending in September 2001. Monetary policy shocks are identified, using the new sign restriction methodology of Uhlig (1999), imposing the "conventional view" that contractionary policy shocks lead to a rise in interest rates and declines in nonborrowed reserves, prices and output. We find that neither the Fed policy choices in 2001 nor those of 2000 were surprising. We provide a method to "explain" these interest rate movements by decomposing them into their sources. Finally, we argue that constant-interest-rate projections like those popular at many central banks are of limited informational value, can be highly misleading, and should instead be replaced by on-the-equilibrium-path projections.

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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 629.

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Date of creation: 2001
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Handle: RePEc:ces:ceswps:_629

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Keywords: monetary policy; vector autoregression; sign restriction; identification; 2001; September 11th;

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  1. Canova, Fabio & Nicolo, Gianni De, 2002. "Monetary disturbances matter for business fluctuations in the G-7," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1131-1159, September.
  2. Cochrane, John H, 1994. "Permanent and Transitory Components of GNP and Stock Prices," The Quarterly Journal of Economics, MIT Press, vol. 109(1), pages 241-65, February.
  3. Eric Leeper & Tao Zha, 2002. "Empirical analysis of policy interventions," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  4. Sims, Christopher A & Zha, Tao, 1998. "Bayesian Methods for Dynamic Multivariate Models," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(4), pages 949-68, November.
  5. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1997. "Monetary policy shocks: what have we learned and to what end?," Working Paper Series, Macroeconomic Issues WP-97-18, Federal Reserve Bank of Chicago.
  6. Athanasios Orphanides, 2001. "Monetary Policy Rules Based on Real-Time Data," American Economic Review, American Economic Association, vol. 91(4), pages 964-985, September.
  7. Scott, Alasdair, 2003. "APPLIED MACROECONOMETRICS Carlo A. Favero Oxford University Press, 2001," Macroeconomic Dynamics, Cambridge University Press, vol. 7(02), pages 313-315, April.
  8. Faust, Jon, 1998. "The robustness of identified VAR conclusions about money," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 49(1), pages 207-244, December.
  9. Eric M. Leeper & Christopher A. Sims & Tao Zha, 1996. "What Does Monetary Policy Do?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(2), pages 1-78.
  10. Christopher A. Sims, 1992. "Interpreting the Macroeconomic Time Series Facts: The Effects of Monetary Policy," Cowles Foundation Discussion Papers 1011, Cowles Foundation for Research in Economics, Yale University.
  11. Jon Faust, 1998. "The robustness of identified VAR conclusions about money," International Finance Discussion Papers 610, Board of Governors of the Federal Reserve System (U.S.).
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Cited by:
  1. Marco Del Negro & Christopher Otrok, 2005. "Monetary policy and the house price boom across U.S. states," Working Paper 2005-24, Federal Reserve Bank of Atlanta.
  2. Nikolay Hristov & Oliver Hülsewig & Timo Wollmershäuser, 2011. "Loan Supply Shocks during the Financial Crisis: Evidence for the Euro Area," CESifo Working Paper Series 3395, CESifo Group Munich.
  3. Bartosz Mackowiak, 2005. "What does the Bank of Japan do to East Asia?," SFB 649 Discussion Papers SFB649DP2005-059, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
  4. BAUWENS, Luc & KOROBILIS, Dimitris, 2011. "Bayesian methods," CORE Discussion Papers 2011061, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  5. Chadha, J.S. & Corrado, L. & Sun, Q., 2008. "Money, Prices and Liquidity Effects: Separating Demand from Supply," Cambridge Working Papers in Economics 0855, Faculty of Economics, University of Cambridge.
  6. Michael T. Owyang, 2002. "Modeling Volcker as a non-absorbing state: agnostic identification of a Markov-switching VAR," Working Papers 2002-018, Federal Reserve Bank of St. Louis.
  7. Peersman, Gert, 2003. "What Caused the Early Millennium Slowdown? Evidence Based on Vector Autoregressions," CEPR Discussion Papers 4087, C.E.P.R. Discussion Papers.
  8. Del Negro, Marco & Otrok, Christopher, 2007. "99 Luftballons: Monetary policy and the house price boom across U.S. states," Journal of Monetary Economics, Elsevier, vol. 54(7), pages 1962-1985, October.
  9. Chadha, Jagjit S. & Corrado, Luisa & Sun, Qi, 2010. "Money and liquidity effects: Separating demand from supply," Journal of Economic Dynamics and Control, Elsevier, vol. 34(9), pages 1732-1747, September.

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