How Monetary Policy Shocks Can Affect Output Asymmetrically
Summary
The paper examines three possible asymmetries between monetary policy and real activity: differences between positive and negative shocks, large and small shocks, and negative shocks under low-variance conditions. It links these patterns to sticky wages and menu-cost pricing. With sticky nominal wages, an unexpected fall in nominal demand can reduce output and employment, while an unexpected increase may have little real effect. Menu-cost models add that firms may respond differently depending on shock size and the inflation environment.
The authors test these ideas on two sets of postwar US quarterly data, first using M1 and then the federal funds rate as a policy measure. M1 results suggest negative shocks may have larger effects, but do not rule out symmetric effects; unstable money demand also makes M1 an imperfect measure of policy shocks. Federal funds rate results provide stronger support for a mixed asymmetry, in which only small negative shocks have real effects. The findings depend on the sample and policy proxy, and the paper cautions that firms’ pricing responses may change as policy becomes more predictable.
Key ideas
- Monetary policy may affect output differently depending on the direction and size of a shock.
- Sticky nominal wages can make unexpected falls in nominal demand reduce output and employment.
- Menu-cost models predict that firms’ price adjustment choices can differ for large and small shocks.
- M1-based evidence is inconclusive about whether positive and negative shocks have symmetric effects.
- Federal funds rate analysis supports a mixed asymmetry in which small negative shocks have real effects.
Tags
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.