The Ambiguous Signaling Channel of Monetary Policy

Excess sensitivity—the significant effects of monetary policy on long-term interest rates—is a well-known puzzle. This paper documents excess sensitivity as being more pronounced in response to monetary policy easing than monetary tightening—the asymmetric excess-sensitivity puzzle. A micro-founded model that rationalizes the findings is proposed. Policy actions signal the economy’s unobserved state because of the central bank’s private information. Knightian uncertainty about the precision of the policy signal and ambiguity-averse preferences give rise to the ambiguous signaling channel of monetary policy. The model predicts that monetary easing has stronger and excessive effects on long-term interest rates but weaker impacts on real GDP than does monetary tightening. I provide evidence that supports the proposed mechanism