Mapping the Federal Reserve's Reaction Function with Directed Acyclic Graphs

55 Pages Posted: 8 Nov 2021 Last revised: 6 Dec 2021

See all articles by James Caton

James Caton

North Dakota State University - Department of Agribusiness and Applied Economics; American Institute for Economic Research; North Dakota State University - NDSU Center for the Study of Public Choice and Private Enterprise

Proma Gupta

North Dakota State University - Department of Agribusiness and Applied Economics

Date Written: October 25, 2021

Abstract

Under the monetary policy framework introduced by Benjamin Bernanke during the 2008 financial crisis, the value of currency in circulation as a proportion of the value of the assets side of the balance sheet has become a choice variable for implementing policy. Before 2008 changes in this variable appear to be incidental, thus providing a natural experiment to evaluate the effects of changes before and after implementation of the new policy framework. While the response of policy to changing economic conditions is straightforward, the response of the macroeconomy to these policy changes needs clear elaboration. We employ directed acyclic graphs (DAGs) to evaluate the response of monetary policy to changing economic indicators. We are interested in mapping the effects of changes in the federal funds rate as well as the effects of changes in the value of assets held by the Federal Reserve. We evaluate the causal chains presented in each DAG by considering the relevant marginal effects as estimated by corresponding seemingly unrelated regressions and vector autoregressions.

Keywords: Monetary Policy, Great Recession, Central Banking, Credit

JEL Classification: E42, E51, E52, E6

Suggested Citation

Caton, James and Gupta, Proma, Mapping the Federal Reserve's Reaction Function with Directed Acyclic Graphs (October 25, 2021). AIER Sound Money Project Working Paper No. 2021-15, Available at SSRN: https://ssrn.com/abstract=3949806 or http://dx.doi.org/10.2139/ssrn.3949806

James Caton (Contact Author)

North Dakota State University - Department of Agribusiness and Applied Economics ( email )

Fargo, ND 58105
United States

American Institute for Economic Research

PO Box 1000
Great Barrington, MA 01230
United States

North Dakota State University - NDSU Center for the Study of Public Choice and Private Enterprise

811 2nd Ave N.
Fargo, ND 58102
United States

Proma Gupta

North Dakota State University - Department of Agribusiness and Applied Economics ( email )

Fargo, ND 58105
United States

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