Signaling Role of Monetary Policy Shocks

This paper introduces a new regime dependence of monetary policy due to information frictions: the effects of monetary policy shocks depend on the type of the fundamental macro shock in the economy. Specifically, output responses to monetary policy shocks are amplified relative to their counterparts in perfect information models when the fundamental macro shock is a productivity level shock or a demand shock. In contrast, output responses are dampened when the fundamental macro shock is a productivity growth rate shock. Households observe the overall fundamental in the economy but cannot distinguish its persistent part from its temporary part. The central bank sets the interest rate tracking a function of the persistent fundamental plus a monetary policy shock, so the interest rate is a noisy signal about the persistent fundamental with the monetary policy shock as the noise. Exogenous monetary policy shocks lead households to update their perceptions about the persistent fundamental differently facing varying types of fundamental macro shocks, thus generating heterogeneous effects on output