The stance of US monetary policy: an alternative measure

Abstract

Knowing the stance of monetary policy is important for its successful implementation. Typically, observers look to the changes in the money supply and short-term interest rates to determine the stance of monetary policy. Sometimes, however, discerning the stance of monetary policy through these measures can be misleading. In this article, an alternative measure of the stance of US monetary policy is proposed and empirically examined, which appears to be a promising improvement over the standard metrics currently used.

Notes

¹This output gap measure is used over the Congressional Budget Office's (CBOs) output gap because the CBO's measure assumes that the growth rate of output does not vary much in the short run. See Weidener and Williams (2009) for more discussion on why this output gap is preferred over the CBO's measure.

²The use of long-run restrictions in VARs was pioneered by Blanchard and Quah (1989) and Shapiro and Watson (1988).

³Although it is apparent that long-run monetary neutrality restriction makes sense for the real variables of y and s, the restriction is also a reasonable one to apply to the nominal interest rate because it mimics the behaviour of the real interest rate in the long run. This is because a one-time permanent monetary policy shock only affects the price level permanently not the inflation.

⁴The augmented Dicker–Fuller and the Phillips–Perron unit root test were used to test for stationarity.

⁵The SE bands are calculated using standard Monte Carlo techniques.