Interest Rate Surprises: A Tale of Two Shocks
Studies that use high-frequency interest rate changes measured around FOMC announcements to identify the effects of monetary policy shocks may not isolate central bank information shocks from pure monetary policy shocks. Instead, they may capture both surprises due to the central bank deviating from its usual stance and surprises due to the central bank's reactions to its private assessment of the economic outlook.
In the former case, a surprise involving a negative interest rate can be expansionary, whereas in the latter case the negative-interest-rate surprise can be contractionary, because the central bank communicates a negative economic outlook by lowering the interest rate presumably to combat economic weakness.
This paper proposes a new technique to isolate central bank information shocks using information on changes in interest rate expectations around macroeconomic news data releases in addition to changes around FOMC announcements. By isolating the shocks, the authors can (1) obtain pure monetary policy shocks that are clean of central bank information and that can be directly compared with monetary policy shocks in standard models, and (2) analyze the impact of new information about the macroeconomy on the overall economy.