We use equity returns to construct a time-varying measure of the interest rate that we call the zero-beta rate: the expected return of a stock portfolio orthogonal to the stochastic discount factor. The zero-beta rate is high and volatile. In contrast to safe rates, the zero-beta rate fits the aggregate consumption Euler equation remarkably well, both unconditionally and conditional on monetary shocks, and can explain the level and volatility of asset prices. We claim that the zero-beta rate is the correct intertemporal price. *We would like to thank Marianne Andries, Adrien Auclert, Jonathan Berk, John Cochrane, Darrell Duffie, Lars Hansen, Benjamin Holcblat, Arvind Krishnamurthy, Eben Lazarus, Mortiz Lenel, Martin Lettau, Hanno Lustig, Thomas Mertens, Monika Piazzesi, Mikkel Plagborg-Møller, Shri Santosh, Martin Schneider, Ken Singleton, David Sraer, Chris Tonetti, and Motohiro Yogo for helpful comments, as well as seminar and conference participants. We would particularly like to thank Rohan Kekre for an excellent discussion of our paper. We would also like to thank Paul Delatte for his research assistance. An earlier version of this paper circulated as “The Zero-Beta Rate.” Replication code (requires a WRDS account): https://github.com/bhebert/TheZeroBetaRate The interest rate is one of the most important prices in a market economy. It captures the intertemporal price of goods and plays a central role in business cycles and monetary policy. In this paper we use equity returns to construct a measure of the interest rate that we call the zero-beta rate: the expected return of a stock portfolio orthogonal to the stochastic discount factor (SDF). Compared to safe rates, the zero-beta rate is high and volatile, and fits a stable aggregate consumption Euler equation remarkably well, both unconditionally and conditionally on monetary shocks. Furthermore, it is high, volatile, and persistent enough to explain the level and volatility of asset prices. We claim that the zero-beta rate is the correct intertemporal price. Our motivation starts with the aggregate consumption Euler equation, 1 = Et [ δ ( ct+1 ct )−σ Rt+1 Pt+1/Pt ]

We propose to exploit stochastic volatility for statistical identification of Structural Vector Autoregressive models (SV-SVAR). We discuss full and partial identification of the model and develop efficient EM algorithms for Maximum Likelihood inference. Simulation evidence suggests that the SV-SVAR works well in identifying structural parameters also under misspecification of the variance process, particularly if compared to alternative heteroskedastic SVARs. We apply the model to study the interdependence between monetary policy and stock markets. Since shocks identified by heteroskedasticity may not be economically meaningful, we exploit the framework to test conventional exclusion restrictions as well as Proxy SVAR restrictions which are overidentifying in the heteroskedastic model.

We identify forward guidance shocks using external instrument structural vector autoregression (SVAR). Contractionary forward guidance shocks raise both future output and price level, and this suggests that monetary policy announcements affect the expected future rate path mainly by revealing policymakers' view on future output and price level, rather than by revealing future policy stance. We also decompose non-monetary structural shocks, and find that positive shocks to output and price level have contractionary impacts on monetary policy. With monetary policy announcements revealing information on output and price level, monetary and non-monetary shocks can share a common element, violating usual instrument SVAR assumptions. We show that our results are robust to the existence of such a common element.

We document that a trading strategy that is short the U.S. dollar and long other currencies exhibits significantly larger excess returns on days with scheduled Federal Open Market Committee (FOMC) announcements. We show that these excess returns (i) are higher for currencies with higher interest rate differentials vis-a-vis the United States, (ii) increase with uncertainty about monetary policy, and (iii) increase further when the Federal Reserve adopts a policy of monetary easing. We interpret these excess returns as compensation for monetary policy uncertainty within a parsimonious model of constrained financiers who intermediate global demand for currencies.

Using French matched administrative-survey data, we quantify the distributional effects of monetary policy on labor income and decompose the extensive and intensive margins of these effects. We find that the effects of ECB monetary policy shocks on labor income are U-shaped along the labor income distribution. These effects are driven by the extensive margin (transitions out or to unemployment) at the bottom of the distribution and by the intensive margin (labor income changes for individuals continuously employed) at the top. We document that sectoral heterogeneity, especially related to the labor force composition, is crucial in explaining these heterogeneous effects.

This paper uses potential outcome time series to provide a nonparametric framework for quantifying dynamic causal effects in macroeconometrics. This provides sufficient conditions for the nonparametric identification of dynamic causal effects as well as clarify the causal content of several common assumptions and methods in macroeconomics. Our key identifying assumption is shown to be non-anticipating treatments which enables nonparametric inference on dynamic causal effects. Next, we provide a formal definition of a "shock'' and this leads to a shocked potential outcome time series. This is a nonparametric statement of the Frisch-Slutzky paradigm. The common additional assumptions that the causal effects are additive and that the treatments are shocks place substantial restrictions on the underlying dynamic causal estimands. We use this structure to causally interpret several common estimation strategies. We provide sufficient conditions under which local projections is causally interpretable and show that the standard assumptions for local projections with an instrument are not sufficient to identify dynamic causal effects. We finally show that the structural vector moving average form is causally equivalent to a restricted potential outcome time series under the usual invertibility assumption.

This paper solves the canonical dynamic rational inattention problem of Sims (2003) by formulating it in the frequency domain. The solution complements and extends existing results, which have been derived in the time domain. The paper provides a simple algorithm that quickly and accurately computes the solution numerically in the frequency domain, and shows how to obtain closed-form solutions when the target is an autoregressive moving average process. The key step to solve the problem is to correctly articulate the “no foresight” constraint. This constraint, often overlooked, restricts agents from processing information about future structural disturbances. The paper also analyzes the consequences of removing the no foresight constraint in a model of the real effects of nominal disturbances.

This paper proposes a novel method for the identification of monetary policy shocks. By applying natural language processing techniques to documents that staff economists at the Federal Reserve prepare for FOMC meetings, we capture the information set of the committee at the time of policy decisions. We verify econometrically that the language contains valuable information beyond what is incorporated in the staff’s numerical forecasts. Using machine learning techniques, we then predict changes in the target interest rate conditional on the committee’s information set and obtain a measure of monetary policy shocks as the residual. We find that the dynamic responses of macro variables to our identified shocks are consistent with the theoretical consensus. A real-time application of our method interprets the 2022 rate hikes as almost entirely systematic.

This paper offers a monetary theory of financial instability. Financial intermediaries’ debt supports trade by serving as a means of payment (“inside money”). Money creation stimulates growth: resources flow towards productive agents through transactions. Money creation also breeds instability: risk accumulates in booms through procyclical intermediary leverage. Under high leverage, even small shocks can significantly deplete intermediaries’ equity capital and drag the economy into a crisis. As a crisis unfolds, intermediaries deleverage and inside money creation collapses. Since intermediaries face recapitalization frictions, the ensuing recovery is slow. As an alternative form of money (“outside money”), government debt may alleviate money shortage. However, it squeezes intermediaries’ profit from money creation, and thereby, slows down their balance-sheet repairment. The latter effect dominates if the government is too timid: a small increase of outside money prolongs a crisis, because the economy still heavily relies on inside money and intermediaries’ recovery. The calibrated model provides quantitative implications on the quantity and price of money and credit, intermediary leverage cycle, and the impact of government debt on the frequency and duration of a crisis. ∗I am deeply indebted to Patrick Bolton, Tano Santos, and José A. Scheinkman for their invaluable guidance. I also thank Tobias Adrian, Geert Bekaert, Nina Boyarchenko, Charles Calomiris, Murillo Campello, Guojun Chen, Olivier M. Darmouni, John Donaldson, Dong Beom Choi, Marco Del Negro, Fernando Duarte, Robert J. Hodrick, Harrison Hong, Gur Huberman, Charles Jones, Christian Julliard, Arvind Krishnamurthy, Siyuan Liu, Marco Di Maggio, Harry Mamaysky, Emi Nakamura, Martin Oehmke, Tomasz Piskorski, Jon Steinsson, Suresh Sundaresan, S. Viswanathan, Chen Wang, and Neng Wang for helpful comments. I am grateful to seminar participants at Columbia Finance PhD Seminar, Columbia Financial Economics Colloquium, Columbia Monetary Economics Colloquium, Federal Reserve Bank of New York, and NYU Finance PhD Seminar. I acknowledge the generous dissertation support from Macro Financial Modeling Group of the Becker Friedman Institute at the University of Chicago. All errors are mine. †Columbia Business School. E-mail: yli17@gsb.columbia.edu

This paper explores weak identification issues arising in commonly used models of economic and financial time series. Two highly popular configurations are shown to be asymptotically observationally equivalent: one with long memory and weak autoregressive dynamics, the other with antipersistent shocks and a near-unit autoregressive root. We develop a data-driven semiparametric and identification-robust approach to inference that reveals such ambiguities and documents the prevalence of weak identification in many realized volatility and trading volume series. The identification-robust empirical evidence generally favors long memory dynamics in volatility and volume, a conclusion that is corroborated using social-media news flow data.

This paper explores the domestic and international effects of an increase in observed interest rates (conventional monetary policy) and expected interest rates (forward guidance). We find significant spillovers to a broad range of countries when both are subject to a tightening shock: Output growth and inflation decelerate and equity returns decline. Currencies of euro area neighboring countries tend to depreciate against the euro. A tightening forward guidance shock triggers more persistent effects on euro area and international interest rates. We find that international effects vary over the sample period when either interest rates are shocked.

This paper examines the impact of carbon pricing on the economy, with a focus on European carbon taxes and the carbon market. Our analysis reveals three key findings. First, while both policies have successfully reduced emissions, the economic costs of the European carbon market are larger than for national carbon taxes. Second, we explore four factors that explain this difference: fiscal policy and revenue recycling, pass-through and sectoral coverage, spillovers and leakage, and monetary policy. Our findings suggest that all four factors play a significant role. Third, we document substantial regional heterogeneity in the impacts of the carbon market, which crucially depend on the share of freely allocated emission permits and the degree of market concentration in the power sector.

This paper derives a new measure of monetary shock for Brazil based on the yield curve. First, the Diebold and Li (2006) model is estimated with nominal yields. The changes of the latent variables of this model surrounding monetary policy meetings are used to analyze the effects on the Brazilian economy. Monetary policy decisions associated with steeper yield curves lead to higher future economic activity.

The Indian economy has been increasingly exposed to external shocks with growing financial and trade integration. We examine the effects of four key international shocks: shocks to US monetary policy, oil supply, global economic policy uncertainty, and geopolitical risk. Using the external instruments strategy with Local Projections and Structural Vector Autoregression methods, we document the dynamic causal effects of these shocks on the Indian economy. We find significant effects of these foreign shocks on both macroeconomic and financial variables. Combined, these shocks explain about 15 to 35 percent of the variation in inflation, output, and financial variables at twoto four-year horizons. However, the magnitude of effects on output is lower relative to both global output and output of peer developing countries. While the oil shock behaves like a traditional supply shock, the US monetary policy and economic policy uncertainty shocks look more like domestic demand shocks. We discuss the implications for stabilization policy.

Measures of monetary shocks commonly give rise to the puzzling result where a monetary tightening has an expansionary effect. A possible reason is that agents may believe that monetary shocks contain information regarding the central bank’s assessment of the economic environment (Nakamura and Steinsson, 2018). Under this hypothesis, the estimated response to monetary policy shocks would contain two conflating effects: the actual effect of monetary policy and the reaction of private agents to the newly acquired information. This paper overcomes this problem by extracting a novel series of monetary shocks using text analysis methods on central bank documents. The resulting text-based variables contain the informational content from changes in the policy rate. Thus, they can be used to extract exogenous changes in monetary policy that are orthogonal to any central bank information. Using this information-free measure of monetary policy shocks reveals that a monetary tightening is not expansionary, even when estimated on more recent periods. Reference Details 2148 Cambridge Working Papers in Economics 2021/21 Cambridge-INET Working Paper Series Published 9 June 2021 Websites www.econ.cam.ac.uk/cwpe www.inet.econ.cam.ac.uk/working-papers A New Monetary Policy Shock with Text Analysis

Macroeconomists increasingly use external sources of exogenous variation for causal inference. However, unless such external instruments (proxies) capture the underlying shock without measurement error, existing methods are silent on the importance of that shock for macroeconomic fluctuations. We show that, in a general moving average model with external instruments, variance decompositions for the instrumented shock are interval-identified, with informative bounds. Various additional restrictions guarantee point identification of both variance and historical decompositions. Unlike SVAR analysis, our methods do not require invertibility. Applied to U.S. data, they give a tight upper bound on the importance of monetary shocks for inflation dynamics.

In this paper, we compare the transmission of a conventional monetary policy shock with that of an unexpected decrease in the term spread, which mirrors quantitative easing. Employing a time-varying vector autoregression with stochastic volatility, our results are two-fold: First, the spread shock works mainly through a boost to consumer wealth growth, while a conventional monetary policy shock affects real output growth via a broad credit/bank lending channel. Second, both shocks exhibit a distinct pattern over our sample period. More specifically, we find small output effects of a conventional monetary policy shock during the period of the global financial crisis and stronger effects in its aftermath. This might imply that when the central bank has left the policy rate unaltered for an extended period of time, a policy surprise might boost output particularly strongly. By contrast, the spread shock has affected output growth most strongly during the period of the global financial crisis and less so thereafter. This might point to diminishing effects of large-scale asset purchase programs.

Identification via heteroskedasticity exploits differences in variances across regimes to identify parameters in simultaneous equations. I study weak identification in such models, which arises when variances change very little or the variances of multiple shocks change close to proportionally. I show that this causes standard inference to become unreliable, outline two tests to detect weak identification, and establish conditions for the validity of nonconservative methods for robust inference on an empirically relevant subset of the parameter vector. I apply these tools to monetary policy shocks, identified using heteroskedasticity in high frequency data. I detect weak identification in daily data, causing standard inference methods to be invalid. However, using intraday data instead allows the shocks to be strongly identified.

IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management. ABSTRACT: Forward-looking monetary policy communication has become a key element of flexible inflation-targeting regimes across advanced and emerging market economies. The Reserve Bank of India’s implementation of a flexible inflation targeting framework since 2016 has been supported by a broad set of communication tools, more recently aided by policy innovations such as forward guidance on policy rates and, asset purchases, increasing the predictability of monetary policy. A review of the recent innovations of monetary policy communications during the initial waves of the pandemic suggests forward guidance likely played a key role in moderating uncertainty and supporting some asset prices. We also find that the relationship between monetary policy surprises and yields for government and corporate securities across all maturities are positive and statistically significant. The results support an important role for monetary policy communication in guiding market expectations about the monetary policy stance, including the likely path of policy interest rates. unanticipated and anticipated policy changes constructed from analysts’ surveys. The results are broadly consistent with those from Tables 3 and 4. The monetary policy surprises, unanticipated changes in the policy rate, on average, have statistically significant impact on the government security and corporate yields, and no effect on the exchange rate and stock market. In their exercise for Indonesia in Ahokpossi et al. (2020) show that the monetary policy surprises have significant impact on the money market rates but not on the bond yields, attributing this to a shallow financial market and incomplete yield curve. However, the findings here suggest that monetary policy surprises impact yields at all maturities are similar to Pescatori (2018), which examines the impact of unanticipated monetary policy changes in Chile.

As the "Volcker shock" is believed to have generated useful information on the effects of monetary policy, this paper develops a transparent procedure to identify other significant monetary contractions. The approach is applied to a panel data set spanning 162 countries (over the period 1970-2017), in which it identifies 147 large monetary contractions. The procedure selects episodes where a protracted period of loose monetary policy was suddenly followed by sizeable interest rate increases. Focusing on contractions of significant size increases the signal-to-noise ratio, while they are unlikely to be accompanied by confounding "information effects" (markets interpreting a rate hike as the Central Bank being optimistic about the real side of the economy). A subsequent panel VAR analysis suggests that, on average, a 100-basis point rate hike reduces real GDP by 0.5 percent. This reduction in output seems to be persistent, pointing to a certain degree of hysteresis. The price level falls by 1.5 percent, indicating that the medium-/long-run impact of contractionary monetary shocks is not characterized by a neo-Fisherian response. Advanced economies appear to display more price stickiness than emerging/developing countries, as the former combine a more muted price response with a larger effect on output. (Copyright: Elsevier)