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What Do Monetary Contractions Do? Evidence From Large Tightenings

Tim Willems

Review of Economic Dynamics, 2020, vol. 38, 41-58

Abstract: As the "Volcker shock" is believed to have generated useful information on the effects of monetary policy, this paper develops a transparent procedure to identify other significant monetary contractions. The approach is applied to a panel data set spanning 162 countries (over the period 1970-2017), in which it identifies 147 large monetary contractions. The procedure selects episodes where a protracted period of loose monetary policy was suddenly followed by sizeable interest rate increases. Focusing on contractions of significant size increases the signal-to-noise ratio, while they are unlikely to be accompanied by confounding "information effects" (markets interpreting a rate hike as the Central Bank being optimistic about the real side of the economy). A subsequent panel VAR analysis suggests that, on average, a 100-basis point rate hike reduces real GDP by 0.5 percent. This reduction in output seems to be persistent, pointing to a certain degree of hysteresis. The price level falls by 1.5 percent, indicating that the medium-/long-run impact of contractionary monetary shocks is not characterized by a neo-Fisherian response. Advanced economies appear to display more price stickiness than emerging/developing countries, as the former combine a more muted price response with a larger effect on output. (Copyright: Elsevier)

Keywords: Monetary policy; Inflation; Output (search for similar items in EconPapers)
JEL-codes: E31 E32 E52 (search for similar items in EconPapers)
Date: 2020
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DOI: 10.1016/

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