Measuring monetary policy

Extending the approach of Bernanke and Blinder (1992), Strongin (1992), and Christano, Eichenbaum, and Evans (1994a, 1994b), we develop and apply a VAR-based methodology for measuring the stance of monetary policy. More specifically, we develop a "demi-structural" VAR approach, which extracts information about monetary policy from data on bank reserves and the federal funds rate but leaves the relationships among the macroeconomic variables in the system unrestricted. The methodology can be used to compare and evaluate existing indicators of monetary policy and also to develop an "optimal" measure (given our framework). Among existing approaches, we find that innovations to the federal funds rate (Bernanke-Blinder) are a good measure of policy innovations during the periods 1965-1979 and 1988-1994; for the period 1979-1994 as a whole, innovations to the orthogonalized component of nonborrowed reserve (Strongin) seems to be the best choice. The new measure of policy stance that we develop conforms well to qualitative indicators of policy such as the Boschen-Mills (1991) index; and innovations to our measure lead to reasonable and precisely estimated dynamic responses by variables such as real GDP and the GDP deflator.