Ben s. Bernanke and Mark Gertler 31 Figure 1 Responses of Output, Prices and Federal Funds Rate to a Monetary Policy Shock 0.008 二二PdR 0.002 0.000 0.002 inflation. The figure shows the estimated dynamic responses of log real GDP, the log of the GDP deflator and the funds rate to a positive, one-standard-deviation shock to the funds rate(which we interpret as an unanticipated tightening of monetary policy). As output and prices are measured in logs, the responses can be interpreted as proportions (that is, 001 =0. 1 percent)of baseline levels According to the estimated response patterns shown in Figure 1, GDP begin to decline about four months after a tightening of monetary policy, bottoming out about two years after the shock. The price level remains inert for about a year, then begins to decline, well after the drop in GDP begins. (The commodity price index, not shown, drops more quickly. Finally, after rising sharply initially, the funds rate begins to fall precipitously after three to four months. Nine to 12 months after the policy innovation, the deviation of the funds rate from its baseline path is only a quarter or less of the initial shock; at two years out, the funds rate is essentially back to trend. These patterns are summarized above as Fact 1. These results in monthly data are quite consistent with the patterns observed by others in quarterly data and or various shorter sample periods. Although we do not show standard error bands in the figures, these responses and all that we report subsequently are statistically significant at conventional levels Sims(1992)and Christiano, Eichenbaum and Evans(1994b)discuss in detail the rationale for including the index of commodity prices; see also Sims and Zha(199%). Inclusion of this variable along with neasures of output and the general price level, has become conventional in the recent VAR-based literature on monetary
Ben S. Bernanke and Mark Gertler 31 Figure I Responses of Output, Prices and Federal Funds Rate to a Monetary Policy Shock 0.008 - Real GDP 0.006 - - - GDP Deflator /I\ - - Funds Rate 0.004 0.002 \ /\ _ 0.000 e -0.002 0 4 8 12 16 20 24 28 32 36 40 44 48 Months inflation.7 The figure shows the estimated dynamic responses of log real GDP, the log of the GDP deflator and the funds rate to a positive, one-standard-deviation shock to the funds rate (which we interpret as an unanticipated tightening of monetary policy). As output and prices are measured in logs, the responses can be interpreted as proportions (that is, .001 = 0.1 percent) of baseline levels. According to the estimated response patterns shown in Figure 1, GDP begins to decline about four months after a tightening of monetary policy, bottoming out about two years after the shock. The price level remains inert for about a year, then begins to decline, well after the drop in GDP begins. (The commodity price index, not shown, drops more quickly.) Finally, after rising sharply initially, the funds rate begins to fall precipitously after three to four months. Nine to 12 months after the policy innovation, the deviation of the funds rate from its baseline path is only a quarter or less of the initial shock; at two years out, the funds rate is essentially back to trend. These patterns are summarized above as Fact 1. These results in monthly data are quite consistent with the patterns observed by others in quarterly data and for various shorter sample periods. Although we do not show standard error bands in the figures, these responses and all that we report subsequently are statistically significant at conventional levels. 7 Sims (1992) and Christiano, Eichenbaum and Evans (1994b) discuss in detail the rationale for including the index of commodity prices; see also Sims and Zha (1993). Inclusion of this variable, along with measures of output and the general price level, has become conventional in the recent VAR-based literature on monetary policy
ofEc Responses of Final Demand and Inventories to a Monetary Policy Shock 0.0008 0.0004 0.0000 0.008 0.0016 To allow us to look at the economy's response to a monetary shock in closer detail,Figure 2 replaces log real GDP from the first VAR with two variables that sum to GDP, final demand and inventory investment, We measure both final de- mand and inventories relative to trend GDP, proxied by a six-year moving average of GDP; this normalization makes the magnitudes of the changes in the two vari- ables comparable(both can be interpreted as fractions of trend GDP)and avoid taking the log of a series(inventory investment) that is sometimes negative. note from Figure 2 that final demand drops quickly following an unanticipated tight ening of monetary policy. In contrast, inventories build up for a period of several months before beginning to decrease, implying that the fall in final demand leads the decline in aggregate production (real GDP). The fall in inventories, when occurs, appears to account for a substantial portion of the initial drop in output, which is consistent with Blinder and Maccini's (1991)evidence on the importance of inventory disinvestment in recessions. These results are summarized as Fact 2 Next, we explore what happens when we include various components of GDP in the VAR used in Figure 1. These series are added one at a time to the base VAR, M We continue to order the funds rate last, which has the effect of assuming that the Fed uses contem- us economic information, but that innovations in monetary policy do not feed back to the rest
32 Journal of Economic Perspectives Figure 2 Responses of Final Demand and Inventories to a Monetary Policy Shock 0.0008 I t I I 0.0004 -0.0004 \ -0.0008 - -0.0012 0 4 8 12 16 20 24 28 32 36 40 44 48 Moniths To allow us to look at the economy's response to a monetary shock in closer detail, Figure 2 replaces log real GDP from the first VAR with two variables that sum to GDP, final demand and inventory investment. We measure both final demand and inventories relative to trend GDP, proxied by a six-year moving average of GDP; this normalization makes the magnitudes of the changes in the two variables comparable (both can be interpreted as fractions of trend GDP) and avoids taking the log of a series (inventory investment) that is sometimes negative. Note from Figure 2 that final demand drops quickly following an unanticipated tightening of monetary policy. In contrast, inventories build up for a period of several months before beginning to decrease, implying that the fall in final demand leads the decline in aggregate production (real GDP). The fall in inventories, when it occurs, appears to account for a substantial portion of the initial drop in output, which is consistent with Blinder and Maccini's (1991) evidence on the importance of inventory disinvestment in recessions. These results are summarized as Fact 2. Next, we explore what happens when we include various components of GDP in the VAR used in Figure 1. These series are added one at a time to the base VAR, although adding them in combinations gives very similar results. To make the magnitudes of changes comparable, the GDP components are also left in levels and normalized by trend GDP.8 Figure 3 shows the responses to a monetary contraction of 8We continue to order the funds rate last, which has the effect of assuming that the Fed uses contemporaneous economic information, but that innovations in monetary policy do not feed back to the rest of the economy until the next month (Bernanke and Blinder, 1992; Bernanke and Mihov, 1995)
Ben s. Bernanke and Mark Gertler 33 ure Responses of Spending Components to a Monetary Policy Shock 0.00021 0.0001 一0.0003 0.006 Business Fixed Investment 00007 some important components of private domestic spending. As noted in Fact 3 above, residential investment drops sharply following a monetary tightening and accounts for a large part of the initial decline in final demand. Next in importance are consumer durables and nondurables, which also contribute significantly to the fall in final de- mand.(Nondurables react by much less in percentage terms than durables do, but they make a similar total contribution to the downturn owing to their larger share in overall economic activity. Figure 3 shows that business fixed investment also declines following a monetary tightening but with a greater lag than other types of spending (Fact 4). An interesting result(not shown in the figure)is that equipment investment accounts for nearly all of the decline in fixed investment; structures investment by businesses appears to respond very little to a monetary policy shock Does the Conventional Story Fit the Facts? In a number of ways, the behavior of the economy shown in Figures 1-3, and s summarized by Facts 1-4, is consistent with the conventional analysis of monetary policy transmission. According to the standard story, the Fed has leverage over th short term real rate because prices are sticky. In turn, the change in real rates affects aggregate demand. The slow response of the gDP deflator in the wake of the mon- etary contraction(Figure 1)and the quick response of final demand(Figure 2)are consistent with this scenario. Apparently, so too is the fact that durables spending- traditionally thought to be the most interest-sensitive part of aggregate demand- displays large responses to monetary policy shocks But there are some important puzzles. First among these is the magnitude of
Ben S. Bernanke and Mark Gertler 33 Figure 3 Responses of Spending Components to a Monetary Policy Shock 0.0002 0.0001 0.0000 l -\-/t -0.0002 \_ / -0.0005 \2 - Consumer Durables \. _/ -- - Nonidurable Conisumption -0.0006 - - Residential Investment Rusincss Fixcd I-ivestmcn-t -0.0007 0 4 8 12 16 20 24 28 32 36 40 44 48 Moniths some important components of private domestic spending. As noted in Fact 3 above, residential investment drops sharply following a monetary tightening and accounts for a large part of the initial decline in final demand. Next in importance are consumer durables and nondurables, which also contribute significantly to the fall in final demand. (Nondurables react by much less in percentage terms than durables do, but they make a similar total contribution to the downturn owing to their larger share in overall economic activity.) Figure 3 shows that business fixed investment also declines following a monetary tightening, but with a greater lag than other types of spending (Fact 4). An interesting result (not shown in the figure) is that equipment investment accounts for nearly all of the decline in fixed investment; structures investment by businesses appears to respond very litfle to a monetary policy shock. Does the Conventional Story Fit the Facts? In a number of ways, the behavior of the economy shown in Figures 1-3, and as summarized by Facts 1-4, is consistent with the conventional analysis of monetary policy transmission. According to the standard story, the Fed has leverage over the short-term real rate because prices are sticky. In turn, the change in real rates affects aggregate demand. The slow response of the GDP deflator in the wake of the monetary contraction (Figure 1) and the quick response of final demand (Figure 2) are consistent with this scenario. Apparently, so too is the fact that durables spendingtraditionally thought to be the most interest-sensitive part of aggregate demanddisplays large responses to monetary policy shocks. But there are some important puzzles. First among these is the magnitude of