Modest Macroeconomic Effects of Monetary Policy Shocks During the Great Moderation: An Alternative Interpretation

Cholesky-VAR impulse responses estimated with post-1984 U.S. data predict modest macroe- conomic reactions to monetary policy shocks. We interpret this evidence by employing an estimated medium-scale DSGE model of the business cycle as a Data-Generating Process in a Monte Carlo exercise in which a Cholesky-VAR econometrician is asked to estimate the effects of an unexpected, temporary increase in the policy rate. Our structural DSGE model predicts conventional macroeconomic reactions to a policy shock. In contrast, our Monte Carlo VAR results replicate our evidence obtained with actual U.S. data. Hence, modest macroeconomic effects may very well be an artifact of Cholesky-VARs. A combination of supply and demand shocks may be behind the inability of Cholesky-VARs to replicate the actual macroeconomic responses. The difference in the VAR responses obtained with Great Inflation vs. Great Mod- eration data may be due to instabilities in the parameters related to households’ and firms’ programs, more than to a more aggressive systematic monetary policy. A Monte Carlo assess- ment of sign restrictions as an alternative identification strategy is also proposed.