NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Monetary Policy Surprises, Credit Costs and Economic Activity

Mark Gertler, Peter Karadi

NBER Working Paper No. 20224
Issued in June 2014
NBER Program(s):Asset Pricing, Economic Fluctuations and Growth, Monetary Economics

We provide evidence on the nature of the monetary transmission mechanism. To identify policy shocks in a setting with both economic and financial variables, we combine traditional monetary vector autoregression (VAR) analysis with high frequency identification (HFI) of monetary policy shocks. We first show that the shocks identified using HFI surprises as external instruments produce responses in output and inflation consistent with both textbook theory and conventional monetary VAR analysis. We also find, however, that monetary policy surprises typically produce "modest movements" in short rates that lead to "large" movements in credit costs and economic activity. The large movements in credit costs are mainly due to the reaction of both term premia and credit spreads that are typically absent from the standard model of monetary policy transmission. Finally, we show that forward guidance is important to the overall strength of the transmission mechanism.

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Document Object Identifier (DOI): 10.3386/w20224

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