International Finance Discussion Papers

<p>We discuss the evolution in macroeconomic thought on the monetary policy transmission mechanism and present related empirical evidence. The core channels of policy transmission - the neoclassical links between short-term policy interest rates other asset prices such as long-term interest rates equity prices and the exchange rate and the consequent effects on household and business demand - have remained steady from early policy-oriented models (like the Penn-MIT-SSRC MPS model) to modern dynamic-stochastic-general-equilibrium (DSGE) models. In contrast non-neoclassical channels such as credit-based channels have remained outside the core models. In conjunction with this evolution in theory and modeling there have been notable changes in policy behavior (with policy more focused on price stability) and in the reduced form correlations of policy interest rates with activity in the United States. Regulatory effects on credit provision have also changed significantly. As a result we review the empirical evidence on the changes in the effect of monetary policy actions on real activity and inflation and present new evidence using both a relatively unrestricted factor-augmented vector autoregression (FAVAR) and a DSGE model. Both approaches yield similar results: Monetary policy innovations have a more muted effect on real activity and inflation in recent decades as compared to the effects before 1980. Our analysis suggests that these shifts are accounted for by changes in policy behavior and the effect of these changes on expectations leaving little role for changes in underlying private-sector behavior (outside shifts related to monetary policy changes).</p><p>This work has been selected by scholars as being culturally important and is part of the knowledge base of civilization as we know it. This work was reproduced from the original artifact and remains as true to the original work as possible. Therefore you will see the original copyright references library stamps (as most of these works have been housed in our most important libraries around the world) and other notations in the work.</p><p>This work is in the public domain in the United States of America and possibly other nations. Within the United States you may freely copy and distribute this work as no entity (individual or corporate) has a copyright on the body of the work.</p><p>As a reproduction of a historical artifact this work may contain missing or blurred pages poor pictures errant marks etc. Scholars believe and we concur that this work is important enough to be preserved reproduced and made generally available to the public. We appreciate your support of the preservation process and thank you for being an important part of keeping this knowledge alive and relevant.</p>