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Noisy Monetary Policy

Tatjana Dahlhaus and Luca Gambetti ()

Staff Working Papers from Bank of Canada

Abstract: We introduce limited information in monetary policy. Agents receive signals from the central bank revealing new information (“news") about the future evolution of the policy rate before changes in the rate actually take place. However, the signal is disturbed by noise. We employ a non-standard vector autoregression procedure to disentangle the economic and financial effects of news and noise in US monetary policy since the mid-1990s. Using survey- and market-based data on federal funds rate expectations, we find that the noisy signal plays a relatively important role for macroeconomic dynamics. A signal reporting news about a future policy tightening shifts policy rate expectations upwards and decreases output and prices. A sizable part of the signal is noise surrounding future monetary policy actions. The noise decreases output and prices and can explain up to 16% and 13% of their variations, respectively. Furthermore, it significantly increases the excess bond premium, the corporate spread and financial market volatility, and decreases stock prices.

Keywords: Business fluctuations and cycles; Econometric and statistical methods; Financial markets; Monetary policy implementation; Transmission of monetary policy (search for similar items in EconPapers)
JEL-codes: E0 E02 E4 E43 E5 E52 (search for similar items in EconPapers)
Pages: 36 pages
Date: 2018
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Handle: RePEc:bca:bocawp:18-23