Download The Dynamic Effects of Forward Guidance Shocks March 4, 2016

The Dynamic Effects of Forward Guidance Shocks
Brent Bundick & A. Lee Smith
Federal Reserve Bank of Kansas City
March 4, 2016
The opinions expressed herein are those of the authors and do not reflect the
views of the Federal Reserve Bank of Kansas City or Federal Reserve System.
Forward Guidance Shocks at the Zero Lower Bound
What are the dynamic effects of forward guidance shocks on
macroeconomic aggregates at the zero lower bound?
⇒ Forward guidance shocks which lower expected future policy
rates increase economic activity and prices.
Can a standard DSGE model generate these estimated dynamics?
⇒ Yes, a small scale New-Keynesian model can generate
similar macroeconomic dynamics.
⇒ Key is to use interest rate futures contracts to discipline
the size of forward guidance shocks in the model.
Forward Guidance Shocks at the Zero Lower Bound
What are the dynamic effects of forward guidance shocks on
macroeconomic aggregates at the zero lower bound?
⇒ Forward guidance shocks which lower expected future policy
rates increase economic activity and prices.
Can a standard DSGE model generate these estimated dynamics?
⇒ Yes, a small scale New-Keynesian model can generate
similar impulse responses.
⇒ Key is to use interest rate futures contracts to discipline
the size of the forward guidance shock in the model.
Our Empirical Approach
We combine a high-frequency event study approach with
traditional monetary VARs.
⇒ Isolate the surprise component of monetary policy from
interest rate futures.
⇒ To measure the macroeconomic effects we input our
high-frequency policy surprises into a monthly VAR.
High-Frequency Identification
Well-suited to extract forward guidance surprises.
⇒ We use a daily event window.
⇒ Implied interest-rate expectations are extracted from
federal funds futures markets.
⇒ We scale the monthly policy surprises to convert them
into FOMC meeting frequency surprises.
VAR Model
We input our high-frequency policy surprises into a monthly VAR
with macroeconomic aggregates.
⇒ Sample is December 2008-December 2014.
Macroeconomic Data: GDP, GDP deflator, Investment, and
Capacity Utilization.
Monetary Policy: The policy surprise associated with the
expected federal funds rate after the 7th
next FOMC meeting.
⇒ Order policy last in a recursive VAR.
Empirical Responses to Forward Guidance Shock
Core Capital Goods
0.15
0.6
0.3
0.1
0.4
0.05
−0.05
Percentage Points
0.4
0
0.2
0
6
12
18
24
30
−0.2
36
GDP Deflator
6
12
18
24
30
36
0.01
Annual Percentage Points
0.15
0.1
0.05
0
0
−0.01
−0.02
Impulse Response
80% Credible Set
−0.05
6
12
18
24
30
36
−0.03
0.2
0.1
0
Funds Rate After 7th Meeting
0.2
Percent
Capacity Utilization
0.8
Percent
Percent
GDP
0.2
6
12
18
24
30
36
−0.1
6
12
18
24
30
36
Forward guidance shocks which lower rates are stimulatory
We have found this result to be robust to:
⇒ Using longer-dated OIS and Eurodollar interest rate futures.
⇒ Using principle components from a vector of interest-rate
futures.
⇒ Using other measures of economic activity and prices.
⇒ Including the release of the minutes and the FOMC chair’s
bi-annual congressional testimony in our event set.
⇒ Alternative VAR orderings.
Mapping results into a DSGE Model
We now estimate a small three variable VAR.
⇒ Consumption and Core PCE prices
⇒ Policy surprise is extracted from the 12-month ahead federal
funds future contract.
These components can be mapped into a small-scale
New-Keynesian model.
Mapping forward guidance shocks into a DSGE Model
Consumption
Price Level
0.15
0.08
0.06
Percent
Percent
0.1
0.05
0
−0.05
6
12
18
24
30
36
12−Month Ahead Futures
Annual Percentage Points
0.02
0
0.01
0
−0.01
−0.02
−0.03
−0.04
0.04
Impulse Response
80% Credible Set
6
12
18
24
30
36
−0.02
6
12
18
24
30
36
Can a standard business cycle generate these estimated
dynamics?
New-Keynesian sticky price model without capital
⇒ Shares features with models by Ireland (2003, 2010).
Firms employ labor & produce
⇒ Quadratic cost of adjusting prices.
Household consumes, works, & receives firm dividends
⇒ External habits in consumption.
⇒ The household’s SDF prices federal funds futures contracts.
Monetary Policy
d
rtd = φr rt−1
+ 1 − φr r + φπ Et−1 πt − π + φx Et−1 xt + νt
rt = max 0, rtd
νt = ρν νt−1 + σ ν ενt
At ZLB: Forward guidance shock.
Away from ZLB: Conventional monetary policy shock.
Solution Strategy and Estimation
The non-linear model is solved using the OccBin toolkit
⇒ Efficient algorithm allows for model estimation.
⇒ A good approximation to the global solution.
Estimate the key model parameters using IRF matching
⇒ Minimize the distance between the data and the model
counterparts following a forward guidance shock.
Simulating a forward guidance shock at the ZLB:
1. Use an aggregate demand shock to drive economy to ZLB.
2. Simulate an innovation to the C.B.’s desired rate.
Can a standard model generate the estimated dynamics?
Price Level
0.08
0.1
0.06
0.05
0.04
Percent
Percent
Consumption
0.15
0
−0.05
−0.1
0
6
12
18
24
30
36
12−Month Ahead Futures
Annualized Percentage Points
0.02
0
−0.02
−0.04
0.02
Empirical
Impulse Response
80% Credible Set
Model
Impulse Response
6
12
18
24
30
36
−0.02
6
12
18
24
30
36
Conclusion
We find no disconnect between empirical evidence of the dynamic
effects of forward guidance shocks and a standard DSGE model.
⇒ Forward guidance shocks revealing lower expected rates
at the zero lower bound are stimulatory.
⇒ A fairly standard model can generate these dynamics.
Key to our approach is using interest rate futures contracts to link
the forward guidance shocks in the data and the model.
Additional Details
Additional Model-Implied Responses
Consumption
Price Level
0.07
Real Interest Rate
0.06
0
0.04
Percent
Percent
0.05
Annual Percentage Points
0.06
0.04
0.03
0.02
0.02
−0.05
−0.1
−0.15
0.01
6
12
18
24
30
0
36
1−Month Ahead Futures
18
24
30
−0.2
36
0.05
0
−0.05
−0.1
6
12
18
24
30
36
12
18
24
30
36
0
−0.02
−0.04
−0.06
−0.08
6
12−Month Ahead Futures
0
Annual Percentage Points
Annual Percentage Points
12
6−Month Ahead Futures
0.1
−0.15
6
Annual Percentage Points
0
6
12
18
24
30
36
FG Shock
Baseline
Scenario
−0.02
FG Shock
Longer
ZLB Episode
Conventional
MP Shock
Away from ZLB
−0.04
6
12
18
24
30
36
Global Solution and OccBin Solution
Consumption
0.05
Price Level
0.035
2.5
Nominal Interest Rate
0.03
Annual Percentage Points
0.04
0.03
Percent
Percent
0.025
0.02
0.02
0.015
0.01
0.01
2
1.5
1
0.5
0.005
12
18
24
30
0
36
1-Month Ahead Futures
0.05
0
-0.05
-0.1
6
12
18
24
30
0
36
6-Month Ahead Futures
0
-0.05
-0.1
6
12
18
24
30
36
12-Month Ahead Futures
0
Annual Percentage Points
Annual Percentage Points
0.05
6
Annual Percentage Points
0
-0.025
-0.05
-0.075
Nonlinear Global Solution
Piecewise Linear OccBin
-0.15
6
12
18
24
30
36
-0.15
6
12
18
24
30
36
-0.1
6
12
18
24
30
36
36 Month USD OIS
GDP
Core Capital Goods
0.5
0.25
0.8
0.4
Percent
Percent
0.6
0.15
0.1
0.4
0.2
0.05
0
0
−0.05
Percentage Points
1
0.2
6
12
18
24
30
−0.2
36
GDP Deflator
6
12
18
24
30
36
0.01
0
Annual Percentage Points
0.2
0.15
0.1
0.05
−0.01
−0.02
−0.03
0
−0.04
−0.05
−0.05
6
12
18
24
30
36
0.3
0.2
0.1
0
36−Month USD OIS
0.25
Percent
Capacity Utilization
0.3
Impulse Response
80% Credible Set
6
12
18
24
30
36
−0.1
6
12
18
24
30
36
GSS Path Factor
GDP
Core Capital Goods
Capacity Utilization
1
0.4
0.75
0.3
Percentage Points
0.15
Percent
Percent
0.25
0.5
0.25
0.05
0
−0.05
6
12
18
24
30
−0.25
36
6
12
18
24
30
36
GSS Path Factor
0.025
Annual Percentage Points
0.2
Percent
0.15
0.1
0.05
0
−0.025
−0.05
0
−0.05
Impulse Response
80% Credible Set
6
12
18
24
30
36
−0.075
0.1
0
GDP Deflator
0.25
0.2
6
12
18
24
30
36
−0.1
6
12
18
24
30
36
Industrial Production
Core Capital Goods
0.3
0.6
0.3
0.2
0.4
0.1
−0.1
Percentage Points
0.4
0
0.2
0
6
12
18
24
30
−0.2
36
Core PPI Finished Goods
6
12
18
24
30
36
0.01
Annual Percentage Points
0.15
0.1
0.05
0
0
−0.01
−0.02
Impulse Response
80% Confidence Interval
−0.05
6
12
18
24
30
36
−0.03
0.2
0.1
0
Funds Rate After 7th Meeting
0.2
Percent
Capacity Utilization
0.8
Percent
Percent
Industrial Production
0.4
6
12
18
24
30
36
−0.1
6
12
18
24
30
36
Expanded Event Set
GDP
Core Capital Goods
0.05
0.4
0.6
0.3
Percentage Points
Percent
Percent
0.15
Capacity Utilization
0.8
0.4
0.2
0
−0.05
6
12
18
24
30
−0.2
36
GDP Deflator
Annual Percentage Points
Percent
6
12
18
24
30
36
0.01
0.15
0.1
0.05
0
0
−0.01
−0.02
Impulse Response
80% Credible Set
−0.05
6
12
18
24
30
36
−0.03
0.1
0
Funds Rate After 7th Meeting
0.2
0.2
6
12
18
24
30
36
−0.1
6
12
18
24
30
36
Policy Ordered First
Core Capital Goods
0.15
0.6
0.3
0.1
0.4
0.05
−0.05
Percentage Points
0.4
0
0.2
0
6
12
18
24
30
−0.2
36
GDP Deflator
6
12
18
24
30
36
0.01
Annual Percentage Points
0.15
0.1
0.05
0
0
−0.01
−0.02
Impulse Response
80% Credible Set
−0.05
6
12
18
24
30
36
−0.03
0.2
0.1
0
Funds Rate After 7th Meeting
0.2
Percent
Capacity Utilization
0.8
Percent
Percent
GDP
0.2
6
12
18
24
30
36
−0.1
6
12
18
24
30
36
Forward Guidance Pre-ZLB
GDP
Core Capital Goods
0.5
Capacity Utilization
2
0.7
1.75
0.6
0.4
1.5
Percentage Points
0.5
1.25
Percent
Percent
0.3
0.2
0.1
1
0.75
0.5
0
6
12
18
24
30
36
0
−0.25
−0.1
6
18
24
30
36
GSS Path Factor
0.05
Annual Percentage Points
0.15
Percent
12
0.075
0.2
0.1
0.05
0.025
0
−0.025
−0.05
0
−0.075
−0.05
−0.1
6
12
18
24
30
36
0.2
0
GDP Deflator
0.25
0.3
0.1
0.25
−0.1
0.4
Impulse Response
80% Credible Set
6
12
18
24
30
36
6
12
18
24
30
36
Relationship to previous work
The Forward Guidance Puzzle
One-Month Extension of Zero Lower Bound Duration
0.03
0.02
0.01
0
6
12
18
2
Annual Percentage Points - Level
Percent Deviation From Baseline
0.035
0.04
0.03
0.025
0.02
0.015
0.01
0.005
0
24
6
12
18
Baseline Prior to FG Shock
Response After FG Shock
1.5
1
0.5
0
24
Nominal Interest Rate
6
12
18
24
One-Year Extension of Zero Lower Bound Duration
Price Level
Consumption
6
5
4
3
2
1
0
6
12
18
24
2
Annual Percentage Points - Level
7
Percent Deviation From Baseline
7
Percent Deviation From Baseline
Percent Deviation From Baseline
Price Level
Consumption
0.05
6
5
4
3
2
1
0
6
12
18
24
Nominal Interest Rate
Baseline Prior to FG Shock
Response After FG Shock
1.5
1
0.5
0
6
12
18
24
Forward Guidance Shocks & Blue Chip Forecasts
Forecast
Differences
Levels
Levels
Lags of Depenedent
Lags of Each
Unemployment Rate
Next Quarter
∆M Pt−1 −1.32∗∗∗
M Pt−1
(0.36)
0.47∗
M Pt−1 −0.45
(0.24)
(0.39)
M Pt−2
1.25∗∗∗
(0.35)
2 quarters ahead
∆M Pt−1 −1.09∗∗∗
M Pt−1
(0.34)
0.45∗∗
M Pt−1 −0.23
(0.19)
(0.27)
M Pt−2
0.95∗∗∗
(0.26)
3 quarters ahead
∆M Pt−1 −0.89∗∗∗
M Pt−1
(0.18)
0.46∗∗
M Pt−1 −0.06
(0.06)
(0.22)
M Pt−2
0.73∗∗∗
(0.16)
4 quarters ahead
∆M Pt−1 −0.66∗∗∗
(0.18)
M Pt−1
0.48∗∗∗
M Pt−1
(0.17)
0.15
(0.22)
M Pt−2
0.48∗∗∗
(0.17)
Forward Guidance Shocks & Blue Chip Forecasts
B.C. 4−Q Urate Forecast
B.C. 4−Q GDP Deflator Forecast
0.05
0.08
0
−0.1
Percent
Percentage Points
0.06
−0.05
−0.15
0.04
0.02
−0.2
0
−0.25
−0.3
6
12
18
24
30
36
GSS Path Factor
0.04
Annual Percentage Points
0.02
0
−0.02
−0.04
−0.06
−0.08
Impulse Response
80% Credible Set
6
12
18
24
30
36
−0.02
6
12
18
24
30
36
Data
Policy Surprises
High-Frequency Policy Surprises
0.4
7th Next FOMC Meeting
GSS Path Factor
36 Month USD OIS
0.4
0.2
0.2
-0.0
-0.0
-0.2
-0.2
-0.4
-0.4
-0.6
-0.6
-0.8
-0.8
2009
2010
2011
2012
2013
2014