A model of monetary policy shocks for financial crises and normal conditions

John Keating, Logan Kelly, Andrew Smith and Victor (Vic) Valcarcel

No RWP 14-11, Research Working Paper from Federal Reserve Bank of Kansas City

Abstract: In late 2008, deteriorating economic conditions led the Federal Reserve to lower the federal funds rate to near zero and inject massive liquidity into the financial system through novel facilities. The combination of conventional and unconventional measures complicates the challenging task of characterizing the effects of monetary policy. We develop a novel method of identifying these effects that maintains the classic assumptions that a central bank reacts to output and the price level contemporaneously and may only affect these variables with a lag. A New-Keynesian DSGE model augmented with a representative financial structure motivates our empirical specification. The equilibrium model provides theoretical support for our choice of different series to replace variables that were popular in models of monetary policy but became problematic in the aftermath of the 2008 financial crisis. One of our most important innovations is to utilize the Divisia M4 index of money as the policy indicator variable. The model is bolstered by its ability to produce plausible responses to a monetary policy shock in samples that include or exclude the recent crisis period.

Keywords: Monetary policy rules; Dynamic Stochastic General Equilibrium (DSGE) models; Money; Output puzzle; Price puzzle; Liquidity puzzle; Financial crisis; Divisia; Identification assumptions; Structural Vector Autoregressions (SVARs) (search for similar items in EconPapers)
JEL-codes: E3 E4 E5 (search for similar items in EconPapers)
Pages: 74 pages
Date: 2014-10-01
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Related works:
Journal Article: A Model of Monetary Policy Shocks for Financial Crises and Normal Conditions (2019)
Working Paper: A Model of Monetary Policy Shocks for Financial Crises and Normal Conditions (2014)
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