Using stock prices to help identify unconventional monetary policy shocks for external instrument SVAR

This paper analyzes the dynamic responses of key U.S. macroeconomic variables to the Fed’s unconventional monetary policy in a newly developed instrumental variable structural VAR framework. A prominent concern is that the high-frequency identified policy surprises may contain news about the economic fundamentals (i.e., “Fed information effect”) in addition to reactions to monetary policy actions. We contribute to the literature by using stock price movements in a heteroskedasticity identification approach, leveraging changes in the relative dominance of economic shocks during different macroeconomic announcements to identify policy surprises that are free of the information effect. Our findings suggest that slope policies implemented by the Fed successfully aided economic recovery by lowering unemployment and credit costs. Importantly, we show that the Fed information effect is not strong enough to substantially bias the estimated policy effect, supporting the common approach that treats high-frequency changes around FOMC announcements as pure policy surprises.