For they know not what they do: an analysis of monetary policy during the Great Moderation

ABSTRACT

In this article, we develop an empirical framework to show the importance of money during the Great Moderation, while accounting for the fact that monetary policy was exclusively conducted through interest rates. We estimate the impulse response functions and forecast error variance decomposition derived from a structural VAR with a least absolute shrinkage and selection operator–based lag selection. The variance decomposition suggests that a substantial component of macroeconomic variation has been driven by shocks to the money market, which were not only unintended by the Federal Reserve, but worse passed unnoticed allowing those shocks to accumulate over time.

KEYWORDS:

• Monetary policy
• Great Moderation
• monetary aggregates
• SVAR
• LASSO

JEL CLASSIFICATION:

• E40
• E52

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ An alternative source for Divisia monetary indices for the United States is the Federal Reserve Bank of St. Louis (Anderson and Jones 2011); however, the data is currently not being updated.