International Transmission of U.S. Monetary Policy Shocks: Evidence from Stock Prices

This paper analyzes intraday changes in firm‐level equity prices around interest rate announcements to assess the transmission of U.S. monetary policy to the global economy. We document that foreign firms on average are roughly as sensitive to U.S. monetary policy as U.S. firms, although we also find considerable cross‐sectional variation across firms. In particular, foreign stocks in cyclically sensitive industries show stronger responses to interest rate surprises, consistent with a demand channel of policy transmission. In addition, transmission of U.S. policy appears to be stronger to economies with fixed exchange rates. Evidence for a credit channel is weaker.     

The Risk‐Taking Channel of Monetary Policy in the U.S.: Evidence from Corporate Loan Data

To study the presence of a risk‐taking channel in the U.S., we build a comprehensive data set from the syndicated corporate loan market and measure monetary policy using different measures, most notably Taylor (1993) and Romer and Romer (2004) residuals. We identify a negative relation between monetary policy rates and bank risk‐taking, especially in the run up to the 2007 financial crisis. However, this effect is purely supply‐side driven only when using Taylor residuals and an ex ante measure of bank risk‐taking. Our results highlight the sensitivity of the potency of the risk‐taking channel to the measures of monetary policy innovations.     

U.S. Monetary Policy Surprises and Currency Futures Markets: A New Look

Intraday currency futures prices react to both surprises in the federal funds target rate (the target factor) and surprises in the anticipated future direction of Federal Reserve monetary policy (the path factor) in similar magnitude, and the reaction is short‐lived. Dollar‐denominated currency futures prices drop significantly in response to positive surprises (i.e., unexpected increases) in the target and path factors, but have generally little response to negative surprises. A monetary policy tightening during expansionary periods leads to an appreciation of the domestic currency, while a monetary policy loosening during recessionary periods tends to have no significant impact.     

Monetary Policy Uncertainty and the Response of the Yield Curve to Policy Shocks

This paper studies the nonlinear response of the term structure of interest rates to monetary policy shocks and presents a new stylized fact. We show that uncertainty about monetary policy changes the way the term structure responds to monetary policy. A policy tightening leads to a significantly smaller increase in long-term bond yields if policy uncertainty is high at the time of the shock. We also look at the decomposition of bond yields into expectations about future policy and the term premium. The weaker response of yields is driven by the fall in term premia, which fall more strongly if uncertainty about policy is high. Conditional on a monetary policy shock, higher uncertainty about monetary policy tends to make securities with longer maturities relatively more attractive to investors. As a consequence, investors demand even lower term premia. These findings are robust to the measurement of monetary policy uncertainty, the definition of the monetary policy shock, and to changing the model specification.     

Inflation,Employment, and Monetary Policy: Objectives and Outcomes in the UK and U.S. Compared

This paper explores how sensitive is monetary policy to the precise preferences of the central bank over inflation and economic activity. It does so in order to address a puzzle—which is that the U.S. Fed and the Bank of England appear to have quite different objectives and yet have adopted strikingly similar policies in recent years. I use a calibrated model to assess how policy might be sensitive to attaching different weights to inflation, output, and the output gap in central bank objectives. I find that a wide range of weights can give rise to rather similar monetary policies.     

U.S. Monetary Regimes and Optimal Monetary Policy in the Euro Area

Monetary policy in the United States has been documented to have switched from reacting weakly to inflation fluctuations during the 1970s, to fighting inflation aggressively from the early 1980s onward. In this paper, I analyze the impact of the U.S. monetary policy regime switches on the Eurozone. I construct a New Keynesian two‐country model where foreign (U.S.) monetary policy switches regimes over time. I estimate the model for the U.S. and the Euro Area using quarterly data and find that the United States has switched between those two regimes, in line with existing evidence. I show that foreign regime switches affect home (Eurozone) inflation and output volatility and their responses to shocks, substantially, as long as the home central bank commits to a time‐invariant interest rate rule reacting to domestic conditions only. Optimal policy in the home country instead requires that the home central bank reacts strongly to domestic producer‐price inflation and to international variables, such as imported goods relative prices. In fact, I show that currency misalignments and relative prices play a crucial role in the transmission of foreign monetary policy regime switches internationally. Interestingly, I show that only marginal gains arise for the Euro Area when the European Central Bank (ECB) adjusts its policy according to the monetary regime in the United States. Thus, a simple time‐invariant monetary policy rule with a strong reaction to Producer Price Index (PPI) inflation and relative prices is enough to counteract the effects of monetary policy switches in the United States.     

Monetary Policy and the Cross-Section of Expected Stock Returns

Ample evidence shows that size and book-to-market equity explain significant cross-sectional variation in stock returns, whereas beta explains little or none of the variation. Recent studies also demonstrate that proxies for monetary stringency increase the explained variation in stock returns. We reexamine a three-factor model that includes beta, size, and book-to-market equity, while allowing monetary conditions to influence the relations between these risk factors and average stock returns. We find that ex-ante proxies for monetary stringency significantly influence the relations between stock returns and all three risk factors. Additionally, all three variables are found to contribute significantly to explaining cross-sectional returns in a three-factor model that includes the monetary sector.     

The Response of Equity Prices to Movements in Long‐Term Interest Rates Associated with Monetary Policy Statements: Before and After the Zero Lower Bound

Monetary policy actions since 2008 have influenced long‐term interest rates through forward guidance and quantitative easing. I propose a strategy to identify the comovement between interest rate and equity price movements induced by monetary policy when an observable representing policy changes is not available. A decline in long‐term interest rates induced by monetary policy statements has a larger positive effect on equity prices prior to 2009 than in the subsequent period. This change appears to reflect the impact of the zero lower bound on short‐term interest rates.     

Monetary Policy and the Natural Rate of Interest

It is most important for monetary policy to track the natural rate of interest when interest rates take large and sustained swings away from their long‐run equilibrium values. Here, we study two models: a standard New Keynesian model and one in which government bonds provide liquidity. Policy rules that cannot track the natural rate perform poorly in both models, but are especially bad in the second because of sustained movements in the natural rate induced by fiscal shocks. First difference rules, on the other hand, do surprisingly well. When model uncertainty is taken into account, the dominance of the first difference rule is even more pronounced.     

Treasury Bond Volatility and Uncertainty about Monetary Policy

We show that dispersion‐based uncertainty about the future course of monetary policy is the single most important determinant of Treasury bond volatility across all maturities. The link between Treasury bond volatility and uncertainty about macroeconomic variables is much stronger than for the more traditional time series measures of macroeconomic volatility and adds beyond the information contained in lagged bond market volatility. Uncertainty about monetary policy subsumes the uncertainty about future inflation (consumer price index and the deflator) and economic activity (unemployment, real and nominal gross domestic product and industrial production). In addition, causality clearly runs one way: from monetary policy uncertainty to Treasury bond volatility.     

Monetary Policy and the Asset Risk‐Taking Channel

How important is the risk‐taking channel for monetary policy? To answer this question, we develop and estimate a quantitative monetary DSGE model where banks choose excessively risky investments, due to an agency problem that distorts banks' incentives. As the real interest rate declines, these distortions become more important and excessive risk taking increases, lowering the efficiency of investment. We show theoretically that this novel transmission channel generates a new monetary policy trade‐off between inflation and real interest rate stabilization, whereby the central bank may prefer to tolerate greater inflation volatility in order to lower excessive risk taking.     

Monetary Policy Expectations at the Zero Lower Bound

We show that conventional dynamic term structure models (DTSMs) estimated on recent U.S. data severely violate the zero lower bound (ZLB) on nominal interest rates and deliver poor forecasts of future short rates. In contrast, shadow‐rate DTSMs account for the ZLB by construction, capture the resulting distributional asymmetry of future short rates, and achieve good forecast performance. These models provide more accurate estimates of the most likely path for future monetary policy—including the timing of policy liftoff from the ZLB and the pace of subsequent policy tightening. We also demonstrate the benefits of including macroeconomic factors in a shadow‐rate DTSM when yields are constrained near the ZLB.     

The Effects of Monetary Policy “News” and “Surprises”

There is substantial agreement in the monetary policy literature over the effects of exogenous monetary policy shocks. The shocks that are investigated, however, almost exclusively represent unanticipated changes in policy, which surprise the private sector and which are typically found to have a delayed and sluggish effect on output. In this paper, we estimate a New Keynesian model that incorporates news about future policies to try to disentangle the anticipated and unanticipated components of policy shocks. The paper shows that the conventional estimates confound two distinct effects on output: an effect due to unanticipated or “surprise” shocks, which is smaller and more short‐lived than the response usually obtained in the literature, and a large, delayed, and persistent effect due to anticipated policy shocks or “news.” News shocks play a larger role in influencing the business cycle than unanticipated policy shocks, although the overall fraction of economic fluctuations that can be attributed to monetary policy remains limited.     

The Interaction of Monetary and Macroprudential Policies

I analyze a New Keynesian dynamic stochastic general equilibrium (DSGE) model where the financing of productive investment is affected by a moral hazard problem. I solve for jointly Ramsey‐optimal monetary and macroprudential policies. I find that when a financial friction is present in addition to the standard nominal friction, the optimal policy can replicate the first‐best allocation if the social planner can conduct both monetary and macroprudential policy. Using monetary policy alone is not enough: a policy trade‐off between stabilizing inflation and output gap emerges. When policy follows simple rules, the source of fluctuations is relevant for the choice of the appropriate policy mix.     

Optimal Monetary Policy in a Model with Agency Costs

This paper integrates a fully explicit model of agency costs into an otherwise standard Dynamic New Keynesian model in a particularly transparent way. A principal result is the characterization of agency costs as endogenous markup shocks in an output‐gap version of the Phillips curve. The model's utility‐based welfare criterion is derived explicitly and includes a measure of credit market tightness that we interpret as a risk premium. The paper also fully characterizes optimal monetary policy and provides conditions under which zero inflation is the optimal policy. Finally, optimal policy can be expressed as an inflation targeting criterion that (depending upon parameter values) can be either forward or backward looking.     

Monetary Policy,Asset Prices,and Liquidity in Over‐the‐Counter Markets

We develop a model where agents can allocate their wealth between a liquid asset, which can be used to purchase consumption goods, and an illiquid asset, which represents a better store of value. Should a consumption opportunity arise, agents may visit a frictional “over‐the‐counter” secondary asset market where they can exchange illiquid for liquid assets. We characterize how monetary policy affects both the issue price and the secondary market price of the asset. We also show that, in contrast to conventional wisdom, search and bargaining frictions in the secondary asset market can improve welfare if inflation is low.     

Japan's Deflation and the Bank of Japan's Experience with Nontraditional Monetary Policy

This paper offers a brief summary of nontraditional monetary policy measures adopted by the Bank of Japan (BOJ) during the last two decades, especially the period 1998–2006, when the so‐called zero interest rate policy (ZIRP) and quantitative easing (QE) were put in place. The paper begins with a typology of policies usable at low interest and inflation rates. They are: strategy (i), management of expectations about future policy rates; strategy (ii), targeted asset purchases; and strategy (iii), QE. Alternatively, QE may be decomposed into a pure attempt to inflate the central bank balance sheet, QE0, purchases of assets in dysfunctional markets, QE1, and purchases of assets to generate portfolio rebalancing, QE2. Strategy (ii), when nonsterilized, is either QE1 or QE2. Using this typology, I review the measures adopted by the BOJ and discuss evidence on the effectiveness of the measures. The broad conclusion is that strategies (i) and (ii) have affected interest rates, while no clear evidence exists so far of the effectiveness of the pure form of strategy (iii), or QE0. Strategy (ii) has been effective especially in containing risk/liquidity premiums in dysfunctional money markets; that is, QE1 has been effective. The effectiveness of QE2, however, is less clear‐cut. The strategies, however, have failed to bring the Japanese economy out of the deflation trap so far. I discuss some possible reasons for this and also implications for the current U.S. situation.     

Accounting for a Shift in Term Structure Behavior with No-Arbitrage and Macro-Finance Models

This paper examines a shift in the dynamics of the term structure of interest rates in the United States during the mid-1980s. We document this shift using standard interest rate regressions and using dynamic, affine, no-arbitrage models estimated for the pre- and post-shift subsamples. The term structure shift largely appears to be the result of changes in the pricing of risk associated with a "level" factor. Using a macro-finance model, we suggest a link between this shift in term structure behavior and changes in the dynamics and risk pricing of the Federal Reserve's inflation target as perceived by investors.