The info channel of monetary policy has disappeared in america
The info channel of monetary policy theory – whereby economic agents revise their beliefs after an urgent monetary policy announcement not merely because they find out about the existing and future path of monetary policy, but also because they learn new information regarding the economic outlook – could explain the puzzle of output increasing after a contractionary monetary policy shock. This column argues, however, that the info channel has disappeared in america, perhaps because of the improved communication strategies implemented by the Federal Reserve.
The info channel of monetary policy (Nakamura and Steinsson 2018) is a recently available theory that may potentially explain the puzzling empirical discovering that output increases after a contractionary monetary policy shock. Based on the information channel theory, economic agents revise their beliefs after an urgent monetary policy announcement not merely because they find out about the existing and future path of monetary policy, but also because they learn new information regarding the economic outlook. This is really because the central bank communicates not merely the near future path of monetary policy, but also how optimistic it really is about the existing and future state of the economy. Thus, when the central bank’s monetary policy tightening can be an endogenous reaction to another state of the economy that’s more positive than markets anticipated, market participants may update their expectations and anticipate that output and inflation might indeed rise. At these times, the responses to a monetary policy shock could be confounded and incorrectly estimated.
Gets the information channel of monetary policy disappeared in america? In a recently available paper (Hoesch et al. 2020), we argue that it has.
We empirically investigate the need for the info channel of monetary policy as time passes. We argue that the recent instabilities in the info could mask the disappearance of the info channel, if not properly considered. The bottom line is, we revisit the empirical evolution of the info channel as time passes using methodologies robust to instabilities and discover that, though it was clearly important historically, its presence has disappeared in the newest years.
We remember that an essential assumption behind the info channel is that the central bank has additional understanding of the state of the economy in accordance with market participants – that’s, it comes with an ‘information advantage’. When it is the case, market participants will update their information regarding the state of the economy predicated on the new information within the central bank’s announcements. Hence, concentrating on the united states, we investigate both how important the ‘information channel’ is, empirically, and if the Federal Reserve does indeed have an ‘information advantage’ in forecasting macroeconomic variables beyond what’s recognized to private forecasters. We study both ‘information channel’ and the ‘information advantage’ using methodologies robust to instabilities, predicated on the fluctuation rationality test developed in Rossi and Sekhposyan (2016). The test provides information on enough time evolution of the current presence of the info channel and the info advantage.
Figure 1 GDP growth: Information advantage fluctuation test
Notes: The solid blue line denotes the Fluctuation t-test statistic estimated in rolling-windows (of size 60 quarters) centred around the date on the x-axis. The test evaluates if the central bank comes with an information advantage in accordance with the private sector in forecasting real GDP growth 1 quarter ahead. The test rejects for test statistic values beyond your 5% critical value bands (red dashed lines).
Specifically, Figure 1 plots the empirical findings on the info advantage. The fluctuation test evaluates if the central bank comes with an information advantage in accordance with the private sector (whose forecasts are given in the Blue Chip Economic Indicator dataset) in forecasting real GDP growth one quarter ahead. When the test statistic (continuous blue line) is beyond your bands (dashed red lines), the info advantage is present, although it disappears when the test statistic is in the bands. Clearly, the info advantage disappeared since 2005. D’Agostino and Whelan (2008) similarly found a reduction in longer horizon predictability in output growth within their sample (ending in 2001); our results highlight, however, that even shorter horizon predictability disappeared, although only recently.
Figure 2 investigates the info channel by splitting the info in two sub-samples, identified by the disappearance of the info advantage. The figure shows the response of the growth rate of industrial production to a contractionary monetary policy shock that may induce a 100 basis-point upsurge in the one-year rate. Before 2004, output increases after a contractionary monetary policy shock à la Gertler and Karadi (2015) unless one uses the information-robust way of measuring monetary policy shocks proposed by Miranda-Agrippino and Ricco (2018). Alternatively, output decreases after 2004 whether or not one runs on the standard monetary policy shock or an information-robust shock.
Figure 2 Informationally robust analysis: 1979-2003 and 2004-2014 subsamples
Notes: Responses to monetary policy shocks in two sub-samples: 1/1/1979-12/31/2003 (left panel) and 1/1/2004-31/12/2014 (right panel). The responses are obtained under different identification assumptions: The blue dashed line denotes Gertler and Karadi’s (2015) average monthly market surprise and the red solid line denotes the informationally robust shock by Miranda-Agrippino and Ricco (2018). The shock is normalised to induce a 100 basis-point upsurge in the one-year rate. The responses are estimated by local projections. Shaded areas are 90% confidence bands predicated on robust standard errors.
Why have the info channel and the info benefit of monetary policy disappeared? We argue that the disappearance of the info advantage relates to the improved communication strategies implemented by the Federal Reserve. The general public has had usage of the Federal Open Market Committee (FOMC) minutes since February 1993, with the lag in the release of the minutes becoming shorter from December 2004 onwards. Furthermore, the Federal Reserve has been releasing FOMC statements since February 1994. Alternatively, the reduction in the short-term information advantage since 2004 is mirrored by a reduction in one- to four-quarter-ahead information advantage in the short-term interest. The latter is linked to the explicit introduction of forward guidance in monetary policy at the same time when the Fed started communicating its expectations about its policy decisions.
D’Agostino, A, D Giannone and P Surico (2006), “Federal Reserve Information Through the Great Moderation”, CEPR Discussion Paper 6594.
D’Agostino, A and K Whelan (2008), “Federal Reserve Information Through the Great Moderation”, Journal of the European Economic Association 6(2-3): 609-620.
Gertler, M and P Karadi (2015), “Monetary Policy Surprises, Credit Costs, and Economic Activity”, American Economic Journal: Macroeconomics 7(1): 44-76.
Hoesch, L, B Rossi and T Sekhposyan (2020), “Gets the Information Channel of Monetary Policy Disappeared? Revisiting the Empirical Evidence”, CEPR Discussion Paper 14456.
Miranda-Agrippino, S and G Ricco (2018), “The Transmission of Monetary Policy Shocks”, CEPR Discussion Paper 13396.
Nakamura, E and J Steinsson (2018), “High-frequency Identification of Monetary Non-neutrality: THE INFO Effect”, The Quarterly Journal of Economics 133(3): 1283-1330.
Rossi, B and T Sekhposyan (2016), “Forecast Rationality Tests in the current presence of Instabilities, With Applications to Federal Reserve and Survey Forecasts”, Journal of Applied Econometrics 31(3): 507-532.