Monetary Policy with Opinionated Markets

78 Pages Posted: 22 Jun 2020 Last revised: 20 Jun 2022

See all articles by Ricardo J. Caballero

Ricardo J. Caballero

Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER)

Alp Simsek

Yale School of Management; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 3 versions of this paper

Date Written: June 17, 2022

Abstract

We build a model in which the Fed and the market disagree about future aggregate demand. The market anticipates monetary policy "mistakes," which affect current demand and induce the Fed to partially accommodate the market's view. The Fed expects to implement its view gradually. Announcements that reveal an unexpected change in the Fed's belief provide a microfoundation for monetary policy shocks. Tantrum shocks arise when the market misinterprets the Fed's belief and overreacts to its announcement. Uncertainty about tantrums motivates further gradualism and communication. Finally, disagreements affect the market's expected inflation and induce a policy trade-off similar to "cost-push" shocks.

Keywords: Monetary policy and shocks, belief disagreements, interest rates, the Fed's Greenbook projections and the dot plot, Fed belief surprises, tantrum shocks, communication, gradualism, overshooting, forward guidance, cost-push shocks.

JEL Classification: E00, E12, E21, E32, E43, E44, G11, G12

Suggested Citation

Caballero, Ricardo J. and Simsek, Alp, Monetary Policy with Opinionated Markets (June 17, 2022). Available at SSRN: https://ssrn.com/abstract=3612949 or http://dx.doi.org/10.2139/ssrn.3612949

Ricardo J. Caballero (Contact Author)

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Alp Simsek

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