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🧵: What does monetary policy do? Our best evidence comes from quality empirical monetary policy shocks (EMPS) using high-frequency and narrative methods. … but what *are* these shocks?

Philip Barrett @phibar.bsky.social and I address this question in a new working paper. In it, we propose a method to extract the news that EMPS contain about future policy, and apply the method to many shocks from the literature. There is a lot to learn!

Background: EMPS are used to evaluate our theories of monetary policy. But this cannot really be done without knowing what the EMPS *are*. EMPS are not just textbook target rate surprises. They also contain “news shocks” about future policy.

Important: surprise shocks have different effects from news shocks at every news horizon. Here’s how they affect prices in the New Keynesian model:

So, if we want to use EMPS to evaluate our theories, we absolutely need to know how they depend on surprise vs news over many horizons. We call this the *Term Structure of Monetary Policy News*. Fortunately: there is a way to estimate this term structure!

Estimation has 4 stages: 1. Instrument for endogenous variables using macro IVs (Barnichon-Mesters) 2. Estimate policy rule by IV 3. Whiten the policy residual to find the innovation 4. Regress on past EMPS (local projection) The coefficients from the final stage = term structure

This is an unbiased estimator of the term structure! We also derive a smooth-local-projection variant. Convenient: both can be written as a single-stage estimator with analytical standard errors (no bootstrap!)

Finding: *all shocks* are mostly news. Even the most surprise-like shocks are <50% due to immediate policy changes. Here’s the Aruoba-Drechsel narrative shock:

Unwelcome news if you wanted to use EMPS to study textbook policy surprises? Fortunately, we offer a way to do that (and more!) Using our method, it is possible to construct a *synthetic* monetary policy shock approximating any desired term structure of policy news!

Application #2: We estimate the macro effects of synthetic MPS. - The synthetic surprise is contractionary, but has no effect on prices. - Instead, deflationary effects of (some) EMPS are due to their long-run news components.