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Nonlinearities, smoothing and countercyclical monetary policy

Laura Jackson Young (), Michael Owyang () and Daniel Soques ()

Journal of Economic Dynamics and Control, 2018, vol. 95, issue C, 136-154

Abstract: Empirical analysis of the Fed’s monetary policy behavior suggests that the Fed smooths interest rates– that is, the Fed moves the federal funds rate target in several small steps instead of one large step with the same magnitude. We evaluate the effect of countercyclical policy by estimating a Vector Autoregression (VAR) with regime switching. Because the size of the policy shock is important in our model, we can evaluate the effect of smoothing the interest rate on the path of macro variables. Our model also allows for variation in transition probabilities across regimes, depending on the level of output growth. Thus, changes in the stance of monetary policy affect the macroeconomic variables in a nonlinear way, both directly and indirectly through the state of the economy. We also incorporate a factor summarizing overall sentiment into the VAR to determine if sentiment changes substantially around turning points and whether they are indeed important to understanding the effects of policy.

Keywords: Time-varying transition probabilities; Markov-switching; Monetary policy (search for similar items in EconPapers)
JEL-codes: C24 E32 (search for similar items in EconPapers)
Date: 2018
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Working Paper: Nonlinearities, Smoothing and Countercyclical Monetary Policy (2016) Downloads
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Journal of Economic Dynamics and Control is currently edited by J. Bullard, C. Chiarella, H. Dawid, C. H. Hommes, P. Klein and C. Otrok

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