An Analysis of the Literature on Monetary Policy Shocks

Monetary policy has been the primary tool of macroeconomic management since the 1970s. As a result, the effects of monetary shocks became an important area of policy research. In the 1980s, event studies showed that U.S. monetary-aggregate announcements strongly affected asset prices, although no single model readily explained the responses. Greater central-bank transparency in the 1980s and 1990s increased interest in measuring monetary policy's effects on financial and macroeconomic variables. In the 1990s, researchers predominantly used vector autoregressions (VARs) to estimate the effects of monetary shocks. This work raised questions about why monetary shocks explained little output variation and sometimes implied theoretically implausible price responses. Increasing Fed transparency allowed researchers to make substantial progress in measuring surprises from high-frequency interest-rate changes. The 2007-2009 Global Financial Crisis further intensified interest in monetary shocks. Subsequent research has examined dimensionality and time variation, information content, predictability, explanatory power, policy horizons, and information sets. Researchers have proposed many measures, but their relationships are often unclear. This paper reviews the literature on monetary shocks, their motivations, their construction, and the inference drawn from them.