Has Monetary Policy Become Less Powerful?

Abstract

Recent vector autoregression (VAR) studies have shown that monetary policy shocks have had a reduced e¤ect on the economy since the beginning of the 1980s. This paper investigates the causes of this change. First, we estimate an identi...ed VAR over the preand post-1980 periods, and corroborate the existing results suggesting a stronger systematic response of monetary policy to the economy in the later period. Second, we present and estimate a fully speci...ed model that replicates well the dynamic response of output, in‡ation, and the federal funds rate to monetary policy shocks in both periods. Using the estimated structural model, we perform counterfactual experiments to quantify the relative importance of changes in monetary policy and changes in the private sector in explaining the reduced e¤ect of monetary policy shocks. The main ...nding is that changes in the systematic elements of monetary policy are consistent with a more stabilizing monetary policy in the post-1980 period and largely account for the reduced e¤ect of unexpected exogenous interest rate shocks. Consequently, there is little evidence that monetary policy has become less powerful.

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