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How Has Empirical Monetary Policy Analysis Changed After the Financial Crisis?

In the wake of the Great Recession, the Federal Reserve lowered the federal funds rate (FFR) target essentially to zero and resorted to unconventional monetary policy. With the nominal FFR constrained by the zero lower bound (ZLB) for an extended period, empirical monetary models cannot be estimated as usual. In this paper, we consider whether the standard empirical model of monetary policy can be preserved without breaks. We consider whether alternative policy instruments (e.g., a long-term interest rate) can be considered substitutes for the FFR over the ZLB period. Furthermore, we compare the shadow rates proposed in Krippner [2012] and Wu and Xia [2016] as alternative measures of the stance of monetary policy. We ask whether the shadow rate is a sufficient representation of the policy instrument or if the financial crisis requires other modifications. We find that, when using a dataset that spans both the pre-ZLB and ZLB periods, the shadow rate acts as a fairly good proxy for monetary policy by producing impulse responses of macro indicators similar to what we’d expect based on the post-WWII, non-ZLB benchmark and by displaying stable parameter estimates when compared to this benchmark.

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