What Do Monetary Contractions Do? Evidence from an Algorithmic Identification Procedure

As the 'Volcker shock' is believed to have generated useful information on the effects ofmonetary policy, this paper develops a simple procedure to identify other unanticipatedmonetary contractions. The approach is applied to a panel data set spanning 162 countries(over the period 1970-2017), in which it identifies 147 large monetary contractions. Theprocedure selects episodes where a protracted period of loose monetary policy was suddenlyfollowed by sizeable nominal interest rate increases. Focusing on contractions of significantsize increases the signal-to-noise ratio, while they are unlikely to be accompanied byconfounding 'information effects' (markets interpreting a rate hike as the Central Bank beingoptimistic about the real side of the economy). A subsequent panel VAR analysis suggeststhat a 100-basis point rate hike reduces real GDP by 0.5 percent. This reduction in outputseems to be persistent, pointing to a certain degree of hysteresis. The price level falls by 1.5percent, indicating that the medium-/long-run impact of contractionary monetary shocks isnot characterized by a neo-Fisherian response. Advanced economies appear to display moreprice stickiness than emerging/developing countries, as the former combine a more mutedprice response with a larger effect on output