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Nonlinearities, smoothing and countercyclical monetary policy

Author

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  • Jackson, Laura E.
  • Owyang, Michael T.
  • Soques, Daniel

Abstract

Empirical analysis of the Fed’s monetary policy behavior suggests that the Fed smooths interest rates– that is, the Fed moves the federal funds rate target in several small steps instead of one large step with the same magnitude. We evaluate the effect of countercyclical policy by estimating a Vector Autoregression (VAR) with regime switching. Because the size of the policy shock is important in our model, we can evaluate the effect of smoothing the interest rate on the path of macro variables. Our model also allows for variation in transition probabilities across regimes, depending on the level of output growth. Thus, changes in the stance of monetary policy affect the macroeconomic variables in a nonlinear way, both directly and indirectly through the state of the economy. We also incorporate a factor summarizing overall sentiment into the VAR to determine if sentiment changes substantially around turning points and whether they are indeed important to understanding the effects of policy.

Suggested Citation

  • Jackson, Laura E. & Owyang, Michael T. & Soques, Daniel, 2018. "Nonlinearities, smoothing and countercyclical monetary policy," Journal of Economic Dynamics and Control, Elsevier, vol. 95(C), pages 136-154.
  • Handle: RePEc:eee:dyncon:v:95:y:2018:i:c:p:136-154
    DOI: 10.1016/j.jedc.2018.08.007
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    2. Jackson, Laura E. & Owyang, Michael T. & Zubairy, Sarah, 2018. "Debt and stabilization policy: Evidence from a Euro Area FAVAR," Journal of Economic Dynamics and Control, Elsevier, vol. 93(C), pages 67-91.
    3. Januj Amar Juneja, 2022. "A Computational Analysis of the Tradeoff in the Estimation of Different State Space Specifications of Continuous Time Affine Term Structure Models," Computational Economics, Springer;Society for Computational Economics, vol. 60(1), pages 173-220, June.
    4. Chen, Peng & Miao, Xinru, 2024. "Understanding the role of China's factors in international commodity price fluctuations: A perspective of monetary-fiscal policy interaction," Economic Analysis and Policy, Elsevier, vol. 81(C), pages 1464-1483.
    5. Oana Simona Hudea, 2018. "Faculty of Business and Administration, University of Bucharest, Romania," Manager Journal, Faculty of Business and Administration, University of Bucharest, vol. 28(1), pages 24-32, December.

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    More about this item

    Keywords

    Time-varying transition probabilities; Markov-switching; Monetary policy;
    All these keywords.

    JEL classification:

    • C24 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Truncated and Censored Models; Switching Regression Models; Threshold Regression Models
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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