Monetary Policy, Real Activity, and Credit Spreads: Evidence from Bayesian Proxy Svars

52 Pages Posted: 20 Jun 2016

See all articles by Dario Caldara

Dario Caldara

Board of Governors of the Federal Reserve System

Edward Herbst

Board of Governors of the Federal Reserve System

Date Written: 2016-05

Abstract

This paper studies the interaction between monetary policy, financial markets, and the real economy. We develop a Bayesian framework to estimate proxy structural vector autoregressions (SVARs) in which monetary policy shocks are identified by exploiting the information contained in high frequency data. For the Great Moderation period, we find that monetary policy shocks are key drivers of fluctuations in industrial output and corporate credit spreads, explaining about 20 percent of the volatility of these variables. Central to this result is a systematic component of monetary policy characterized by a direct and economically significant reaction to changes in credit spreads. We show that the failure to account for this endogenous reaction induces an attenuation bias in the response of all variables to monetary shocks.

Keywords: Bayesian Inference, Monetary policy, Vector Autoregressions

JEL Classification: E52, C3, C5

Suggested Citation

Caldara, Dario and Herbst, Edward, Monetary Policy, Real Activity, and Credit Spreads: Evidence from Bayesian Proxy Svars (2016-05). FEDS Working Paper No. 2016-049. Available at SSRN: https://ssrn.com/abstract=2797565 or http://dx.doi.org/10.17016/FEDS.2016.049

Dario Caldara (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Edward Herbst

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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