Mapping the Federal Reserve's Reaction Function with Directed Acyclic Graphs
55 Pages Posted: 8 Nov 2021 Last revised: 6 Dec 2021
Date Written: October 25, 2021
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: Suggested Citation