Search Results
Journal Article
Has the Market’s Perception of the FOMC’s Reaction Function Changed since the Onset of the COVID-19 Pandemic?
A monetary policy reaction function typically describes how a central bank’s policy rate responds to changes in economic fundamentals, such as inflation and labor market conditions, and other factors. We use minute-by-minute data on two-year Treasury yields to study the market-expected monetary policy reaction function from 2004 to 2024. We find that financial markets expected monetary policy to react more aggressively to inflation news during 2022–2024 than in the pre-COVID-19-pandemic period. In addition, we find that the sensitivity of the two-year Treasury yield to economic news other ...
Journal Article
How Do Monetary Policy Surprises Affect Household Sentiment?
We examine the effect of monetary policy surprises, or unexpected changes in the federal funds rate, on household sentiment. We first assume that the effect of monetary policy surprises does not depend on the state of the economy, as is noted in the literature, and find that household sentiment is not sensitive to monetary policy surprises. We then hypothesize that the effect of monetary policy surprises changes with certain economic environments. We find that when inflation was low in the previous month, an unexpected policy rate hike significantly boosts sentiment. Contrastingly, when ...
Journal Article
The Information Effect of Monetary Policy: Self-Defeating or Optimal?
As the Federal Reserve has become more transparent about its decisions on the federal funds target rate, the general public has begun to regard the rate as not only a benchmark interest rate, but also as a signal about the state of the economy. However, the specific information considered by the public to be revealed is not clearly understood. We investigate this question and find that the information revealed by monetary policy decisions is regarding future output growth, not inflation, and that such an information effect is theoretically optimal and does not make interest-rate policies ...
Journal Article
Forward Guidance during the Pandemic: Has It Changed the Public’s Expectations?
In responding to the COVID-19 crisis, the Federal Reserve has both lowered the federal funds rate and provided forward guidance. We study whether the forward guidance given with the April and June 2020 FOMC meetings altered the public’s expectations of future policy rates, GDP growth, and inflation. We find that forward guidance was effective in altering the public’s expectations about future policy rates if it was accompanied by an SEP but not expectations about economic fundamentals. We suggest that the difference might be explained by FOMC statements being interpretable in two ...
Journal Article
Average Inflation Targeting in a Low-Rate Environment
One significant change in the US economy in the last 20 years is the trend decline in real interest rates that pushes the policy rate near the effective lower bound (ELB) and puts downward pressure on inflation. This environment leaves conventional monetary policy tools less effective in accommodating adverse shocks. To better achieve the Federal Reserve’s dual mandate at the ELB, the FOMC adopted a new framework called average inflation targeting (AIT). In this Commentary, I demonstrate that AIT is a better policy in a low-rate environment because of its ability to anchor inflation ...
Journal Article
Monetary Policy since the Onset of the COVID-19 Pandemic: A Path-Dependent Interpretation
Some argue that the Fed underreacted to rising inflation in 2021 after the US economy started to recover from the COVID-19 crisis. By using data from the Summary of Economic Projections (SEP), we surmise that the FOMC expected to keep the federal funds rate near zero by the end of 2021, but at the same time, the committee also expected to make the policy rate catch up to inflation over the next two years. We then argue that the Fed chose this gradual approach in response to the negative demand shock that pushed the policy rate to its effective zero lower bound. Economic literature on optimal ...
Journal Article
Financial Markets’ Perceptions of the FOMC’s Data-Dependent Monetary Policy
Over the past ten years, the Federal Open Market Committee (FOMC) has repeatedly emphasized that future policy is data dependent. In this Economic Commentary, we investigate how financial markets expected future interest rates to change with the release of new data on inflation and labor market conditions. We find that the surprises in economic indicators have a stronger effect on the 2-year Treasury yield than on the expected federal funds rate to be set in the next FOMC meeting. This implies that markets understand that under the data-dependent approach, policy decisions do not heavily rely ...
Working Paper
Rising Skill Supply, Technological Changes, and Innovation: A Quantitative Exploration of China
Can the expansion of higher education lead to firm productivity growth? In this paper, we examine how China's college expansion program contributes to the rapid growth of firms' R&D expenditure and productivity. In our model, heterogeneous firms make endogenous R&D decisions, requiring them to allocate skilled workers between production and R&D. We structurally estimate the model using firm-level data on the level and distribution of R&D, as well as macro-level data on skill prices and sectoral allocation. Quantitative analysis reveals that between 2004 and 2018, the combination of the ...
Working Paper
The Information Effect, Policy Rule Ambiguity, and the Decomposition of Monetary Policy Surprises
I study a New Keynesian economy in which the private sector has imperfect information about both the underlying shock and the monetary policy rule. The information effect of monetary policy makes the two sources of imperfect information interact with each other. On the normative side, I show that the conventional certainty equivalence result regarding optimal monetary policy breaks down. The optimal policy rule becomes less responsive to the underlying shock, and depends on the degree of rule ambiguity. On the positive side, in a dynamic New Keynesian model calibrated to the US economy, I ...
Working Paper
Forward Guidance under Imperfect Information: Instrument Based or State Contingent?
I study the optimal type of forward guidance in a flexible-price economy in which both the private sector and the central bank are subject to imperfect information about the aggregate state of the economy. In this case, forward guidance changes the private sector?s expectations about both future monetary policy and the state of the economy. I study two types of forward guidance. The first type is instrument based, in which case the central bank commits to a value of the policy instrument. The second type is state contingent, in which case the central bank reveals its imperfect information and ...