Thursday, March 26, 2015

Fed has no effect on the economy

The Fed follows the market, and often has no effect on the market. And nobody else than Christopher A. Sims, Nobel Prize in Econ 2011 winner says this (explicitly), in his work, which you can get a sample of online. Sims found a lag between Fed action and an economy’s response, with two key points: often the action and response were uncorrelated (had no effect), and the Fed *reacted* to the market in setting rates. BTW Sims is NOT a ‘real business cycle’ advocate, so you cannot say he is blinded by this framework. Source: – Leeper, Sims, and Zha (1996). “2 Another robust conclusion, common across these models, is that a large fraction of the variation in monetary policy instruments is attributable to systematic ***reaction*** by policy authorities to the state of the economy. This is of course what we would expect of good monetary policy, but it is also the reason why using the historical behavior of aggregate time series to uncover the effects of monetary policy is difficult. The size of effects attributed to shifts in monetary policy varies across specifications of economic behavior. We show, though, that most of the specifications imply that ***only a modest*** portion (or in some cases, ***essentially none***) of the variance of output or prices in the US since 1960 is attributable to shifts in monetary policy. Furthermore, we point out substantive problems in the models that imply large real effects, and argue that correcting these problems lowers the implied size of the real effects.”