Contractionary Monetary Shock Research Articles

International monetary spillovers to frontier financial markets: Evidence from Bangladesh

AbstractThis paper investigates international monetary spillovers to stock prices in Bangladesh, a frontier market that has been excluded from prior studies in the literature. Using daily stock price data for over 300 publicly traded firms in a high‐frequency event study framework, we find that contractionary monetary shocks originating from the US, euro area, and China lower stock prices, with Chinese monetary shocks having the largest impact. Contractionary shocks originating from India, on the other hand, lead to a statistically significant increase in stock returns. The positive response is driven by a small number of policy decisions. When these outlier decisions are removed from the sample, contractionary Indian monetary shocks lead to a decline in stock prices in line with spillovers from the other countries.

Local policy uncertainty and the firm's investment reaction to monetary policy

Rising local economic policy uncertainty increases the firm's capital investment sensitivity to monetary shocks. This effect is driven by the tendency of uncertainty-driven precautionary behavior to increase the firm's propensity to reduce investment in response to contractionary monetary shocks. This effect is more pronounced for geographically bound firms that are financially constrained. Our results show how the investment effects of local economic policy uncertainty are entangled with the asymmetries that govern the economic impact of monetary policy.

Presidential Address: Does Monetary Policy Matter? The Narrative Approach after 35 Years

The narrative approach to macroeconomic identification uses qualitative sources, such as newspapers or government records, to provide information that can help establish causal relationships. This paper discusses the requirements for rigorous narrative analysis using fresh research on the impact of monetary policy as the focal application. We read the historical Minutes and Transcripts of Federal Reserve policymaking meetings to identify significant contractionary and expansionary changes in monetary policy not taken in response to current or prospective developments in real activity for the period 1946 to 2016. We find that such monetary shocks have large and significant effects on unemployment, output, and inflation in the expected directions. Analysis of available policy records suggests that a contractionary monetary shock likely occurred in 2022. Based on the empirical estimates of the effect of previous shocks, one would expect substantial negative impacts on real GDP and inflation in 2023 and 2024. (JEL E31, E52, E58, E65, N12)

Uncertainty and corporate investments in response to the Fed's dual shocks

AbstractThe Federal Reserve's impact on corporate investments varies with the type of monetary shock. From a conventional standpoint, contractionary monetary shocks trigger a rise in financing costs that significantly reduce investment. Such effects are predicted by the widely investigated monetary policy channels. However, we highlight informational circumstances under which monetary contraction reduces uncertainty and incentivizes a rise in investment. These effects arise when monetary tightening conveys a positive assessment of the macroeconomic outlook by the Fed. We further show that the positive effect of contractionary Fed information shocks on investment is largely driven by these shocks’ ability to reduce uncertainty.

Monetary shocks and the analyst coverage of the firm

Contractionary monetary shocks, which are known to reduce growth and tighten lending, significantly reduce firm-level analyst coverage. The reduction in analyst coverage of high-leverage firms is almost 50% larger, and faster, than the reduction in the coverage of low-leverage firms.

Monetary policy and anxious presidents: The effects of monetary shocks on presidential job approval

AbstractUsing high‐frequency identification, I show that the Federal Reserve significantly influences its political environment. A 50‐bp exogenous contractionary monetary shock is associated with a decline in the U.S. president's job approval by up to five percentage points in the subsequent 12 to 24 months. This loss exceeds the victory margin in six out of the eight latest elections. My findings also suggest that presidents who are in the second half of their terms are particularly vulnerable to monetary shocks. Such vulnerability is largely explained by the evolving attitudes toward key macroeconomic factors like unemployment and inflation over the presidential life cycle.Related ArticlesCho, Sungdai, and Garry Young. 2008. “The Asymmetric Impact of Inflation on Presidential Approval.” Politics & Policy 30(3): 401–30. https://doi.org/10.1111/j.1747‐1346.2002.tb00128.xHazakis, Konstantinos J. 2015. “The Political Economy of Economic Adjustment Programs in the Eurozone: A Detailed Policy Analysis.” Politics & Policy 43(6): 822–54. https://doi.org/10.1111/polp.12141Pulatov, Abdullo, and Ahmad Hassan Ahmad. 2021. “Political Business Cycles in Post‐Communist European Countries.” Politics & Policy 49(5): 1248–69. https://doi.org/10.1111/polp.12427

Fiscal Regimes and the Exchange Rate

In this paper, we argue that the effect of monetary and fiscal policies on the exchange rate depends on the fiscal regime. A contractionary monetary (expansionary fiscal) shock can lead to a depreciation, rather than an appreciation, of the domestic currency if debt is not backed by future fiscal surpluses. We look at daily movements of the Brazilian real around policy announcements and find strong support for the existence of two regimes with opposite signs. The unconventional response of the exchange rate occurs when fiscal fundamentals are deteriorating and markets' concern about debt sustainability is rising. To rationalize these findings, we propose a model of sovereign default in which foreign investors are subject to higher haircuts and fiscal policy shifts between Ricardian and non-Ricardian regimes. In the latter, sovereign default risk drives the currency risk premium and affects how the exchange rate reacts to policy shocks.

The role of heterogeneity in price rigidities for delayed nominal exchange rate overshooting

This paper develops an open economy New Keynesian model in which shocks to monetary policy generate delayed nominal exchange rate overshooting. We show analytically that delayed overshooting is a consequence of heterogeneity in nominal price rigidities. Immediately after a contractionary monetary shock, the reaction of firms with relatively flexible prices generates a strong response of inflation, alongside a currency appreciation. Overtime, as firms with relatively less flexible prices adjust, the appreciation continues, but is subsequently followed by a depreciation. In a calibrated version of the model, with heterogeneity in price rigidity matched with micro-evidence, the peak response of the nominal exchange rate to a monetary policy shock occurs at around 4 quarters.

Do flexible working hours amplify or stabilize unemployment fluctuations?

In this paper we challenge the conventional view that increasing working time flexibility limits the amplitude of unemployment fluctuations. We start by showing that hours per worker in European countries are much less procyclical than in the US, and even co-move negatively with output in selected economies. This is confirmed by the results from a structural VAR model for the euro area, in which hours per worker increase after a contractionary monetary shock, exacerbating the upward pressure on unemployment. To understand these counterintuitive results, we develop a structural search and matching macroeconomic model with endogenous job separations that resemble layoffs. We show that this feature is key to generating a countercyclical response of hours per worker. When we augment the model with frictions in working hours adjustment and estimate it using euro area time series, we find that increasing flexibility of working time amplifies cyclical movements in unemployment.

Systemic risk: The coordination of macroprudential and monetary policies in China

The literature documents the effects of monetary and macroprudential policies in controlling systemic risk, but empirical evidence of a systemwide framework that effectively coordinates the two policies is lacking. This study assesses the effectiveness, channels, and timeliness of monetary and macroprudential policies’ impacts on systemic risk in China from January 2009 to June 2018, and contributes to the discussion of how to coordinate these policies. Using an index synthesized from 28 indicators to proxy China’s systemic risk, we find the following: (1) A contractionary monetary (macroprudential) shock increases (reduces) systemic risk over the entire shock time period. (2) Macroprudential (monetary) policy is effective in the long (short) term. (3) The systemic risk intervention effect of monetary (macroprudential) policy is channeled through inflation control (asset price stability).

What do monetary contractions do? Evidence from large tightenings

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.

Monetary Policy, Natural Resources, and Federal Redistribution

Can monetary policy shocks induce redistribution across natural resource rich and poor states within a federation? We conjecture that resource-rich states are capital intensive, hence their investment is more responsive to changes in monetary policy. Consequently, contractionary monetary policy shocks (e.g., increases in the interest rate) may induce redistribution from resource-poor states to resource-rich ones, via an equalizing federal transfer scheme, because investment is reduced more strongly in the latter. We test these hypotheses using a panel of U.S. states covering several decades, and find that: (1) resource-rich states are significantly and persistently more capital intensive; (2) contractionary monetary policy shocks induce a relative drop (increase) in investment (federal transfers) in resource-rich states, over the course of four years; (3) these patterns are driven by resource-induced differences in the capital share in the economy. We estimate that a one standard deviation contractionary monetary shock induces, within the first year, federal redistribution of approximately $$\$2.5$$ billion from the resource-poor to the resource-rich states, representing about $$11\%$$ of the total average annual federal transfers received by the latter states.

What Do Monetary Contractions Do? Evidence From An Algorithmic Identification Procedure

As the “Volcker shock” is believed to have generated useful information on the effects of monetary policy, this paper develops a simple procedure to identify other unanticipated 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 nominal 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 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.

What Do Monetary Contractions Do? Evidence from an Algorithmic Identification Procedure

As the “Volcker shock” is believed to have generated useful information on the effects of monetary policy, this paper develops a simple procedure to identify other unanticipated 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 nominal 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 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.

Transmission of Monetary Policy in Times of High Household Debt

English Abstract: This paper explores whether the effectiveness of monetary policy can be affected by the degree of household indebtedness. We take an interacted panel VAR approach using a panel of 28 countries and thereby obtain several interesting findings. That is, the responses of consumption and investment to monetary shocks are stronger in the state of high household debts. Such responses furthermore become larger in a contractionary monetary policy stance rather than in an expansionary one. Finally, we find that the negative impact of contractionary monetary shocks on the real economy is stronger in the countries with a higher share of adjustable rate loans. We conjecture that these findings lend support for the presence of “cash flow channel” with respect to the transmission of contractionary monetary policy. Korean Abstract: 본고는 28개국의 1984~2015년 중 국가패널자료를 대상으로 교차패널 VAR모형을 이용하여 통화정책의 유효성이 가계부채 수준에 의해 어떻게 영향을 받는지에 관한 분석을 시도하였다. 분석 결과, 통화정책 충격 발생 시 소비 및 고정투자가 가계부채가 높은 경우 더욱 크게 반응하는 것으로 나타났다. 더 나아가 그러한 반응의 크기는 확장적 통화정책 기조에서보다 긴축적 기조에서 더욱 두드러진 것으로 추정되었다. 아울러 긴축적 통화정책이 실물부문에 미치는 부정적 영향이 변동금리 대출 비중이 높은 국가에서 더욱 두드러진 것으로 분석되었다. 이러한 분석 결과에 비추어 볼 때, 긴축적 통화정책의 파급경로에서 “현금흐름 경로”(cash flow channel)가 작용하는 것으로 판단된다.

Monetary Policy Shocks, Financial Structure, and Firm Activity: A Panel Approach

This paper assesses the differences in how nonfinancial firms respond to high frequency identified monetary policy shocks conditional on various measures of their financial conditions. In line with the effects of monetary policy shocks on real aggregate activity, the most significant disparities between firms arise slowly, over a horizon of approximately 4 to 12 quarters after a shock. Among the explanatory financial variables considered, both higher leverage and lower liquid asset holdings at the time of a contractionary monetary shock tend to predict relatively lower fixed capital, inventory and sales growth in the cross-section of firms. When simultaneously controlling for both the relevance of leverage and liquid assets, it is the latter that explains the disparities over the longer horizon. Low liquid asset holdings are also shown to be associated with stronger pass-through to borrowing costs.

Monetary shocks and sticky wages in the U.S. great contraction: A multi-sector approach

We quantify the role of contractionary monetary shocks and nominal wage rigidities in the U.S. Great Contraction. In contrast to conventional wisdom, we find little increase in the economy-wide real wage over 1929–33, although real wages rose significantly in some industries. In the context of a two-sector model with intermediates and nominal wage rigidities in one sector, contractionary monetary shocks account for only a third of the fall in GDP. Intermediate linkages play an important role, as the output decline without intermediates is almost a third larger at the trough. The role of nominal wage rigidities beyond their interaction with monetary shocks is limited.

Central Bank Information and the Effects of Monetary Shocks

Does the effect of monetary policy depend on the macroeconomic information released by the central bank? Because differences between central bank’s and private agents’ information sets affect private agents’ interpretation of policy decisions, this paper aims to investigate whether the publication of macroeconomic information by the central bank modifies private responses to monetary policy. We assess the non-linear effects of monetary shocks conditional on the Bank of England’s macroeconomic projections on UK private inflation expectations. We find that inflation projections modify the impact of monetary shocks. When contractionary monetary shocks are interacted with positive (negative) projections, the negative effect of policy on inflation expectations is amplified (reduced). This suggests that providing guidance about central bank future expected inflation helps private agents’ information processing, and therefore changes their response to policy decisions.

Short-Run and Long-Run Effects of Monetary Policy on GDP in Iran

In this paper, we investigated the short-run and long-run effects of monetary policy on GDP have been investigated by co-integration analysis in Iran economy during the period 1972-2015. We used Johansen cointegration methods to demonstrate long-term relationship between the variables. The results showed that the Contractionary monetary shocks, has low effects on output whereas the effects of expansionary monetary shocks are neutral. The effects of expansionary monetary shocks after a first lag have significant effects on increasing output. Among the control variables, the investment ratio, inflation, government expenditures, oil revenues and coefficient of exchange rate have significant expected effects on production growth. In addition, there is a long-run relationship between money supply, inflation and output.

Monetary shocks, macroprudential shocks and financial stability

This paper examines the implications of monetary shocks and macroprudential shocks for aggregate financial fragility using a sign restricted VAR model estimated with US data spanning the period 1960Q1–2007Q4. Contractionary monetary shocks are found to exacerbate financial fragility, increasing both the credit to GDP ratio and the ‘financial ratio’, which is the ratio of firms' debts to their internal funds. By contrast, when interest rates are fixed, credit-constraining macroprudential shocks may be able to reduce the credit to GDP ratio in the short run but are not able to reduce the financial ratio. However, when the interest rate is free to accommodate the macroprudential shock, both the credit to GDP ratio and the financial ratio decline, indicating a reduction of financial fragility and suggesting that there may be gains from a coordinated approach to macroeconomic management.