Forward guidance matters: Disentangling monetary policy shocks

Central banks have usually employed short-term rates as the main instrument of monetary policy. In the last decades, however, forward guidance has also become a central tool. This paper combines two sources of extraneous information - high frequency surprises and narrative evidence - with sign restrictions in a structural vector autoregressive (VAR) model to disentangle forward guidance from conventional monetary policy. Results show that conventional monetary policy has the expected effects on industrial production even in a recent US sample and that forward guidance is an effective policy tool, being at least as strong as conventional monetary policy.