How Has Empirical Monetary Policy Analysis Changed After the Financial Crisis?

Abstract

In the wake of the Great Recession, the Federal Reserve lowered the federal funds rate target essentially to zero and resorted to unconventional monetary policy. With the nominal FFR constrained by the zero lower bound (ZLB) for an extended period, empirical monetary models cannot be estimated as usual. In this paper, we consider whether the standard empirical model of monetary policy can be preserved without breaks. We consider whether alternative policy instruments (e.g., the size of the balance sheet) can be considered substitutes for the FFR over the ZLB period. Furthermore, we construct a shadow rate via the method proposed in Krippner [2012] to represent an alternative measure of the stance of monetary policy and compare this with the shadow rate of Wu and Xia [2014]. We ask whether the shadow rate is a suffi cient representation of the policy instrument or if the financial crisis requires other modifications. We find that, if using a dataset that spans the pre-ZLB period throughout the ZLB environment, the shadow rate acts as a fairly good proxy for monetary policy by producing impulse responses of macro indicators similar to what we’d expect based on the post-WWII, non-ZLB benchmark. However, the linear model exhibits a significant structural break at the onset of the ZLB and the shadow rate may still be insuffi cient for examining the ZLB period in isolation. ∗The authors benefitted from conversations with Anusha Chari and Leo Krippner and conference participants at the SNDE, CEF, and Midwest Macro. Kate Vermann provided research assistance. The views expressed here are the authors’alone and do not reflect the opinions of the Federal Reserve Bank of St. Louis or the Federal Reserve System. †owyang@stls.frb.org