In economic literature on monetary policy, the concept of « monetary policy shock » is often mentioned. For several years now, monetary economics research has focused on the effects of these « shocks » on the economy in order to determine whether monetary policy alone has a significant impact on the real economy. But what does this really mean?
It is commonly said that a central bank sets its key interest rate by taking into account movements in real variables, such as inflation and GDP, for example (to put it simply). The real variables to which a central bank is supposed to react are most often dictated by its statutes. For example, it is clear that the Fed reacts to both inflation and GDP (dual objective), while the ECB is primarily concerned with inflation.
Let’s imagine that the Fed has a clear objective of responding only to GDP and inflation. Let’s imagine that in October, when inflation is not a threat to the Fed and GDP is below the Fed’s target, the Fed decides to change its monetary policy by raising its key interest rate. This decision would not be motivated by the real variables to which the Fed is supposed to respond: this would be referred to as a « monetary policy shock. »
More generally, in this context, we can refer to a « monetary policy shock » to describe episodes where monetary policy movements cannot be justified by movements in real variables in the economy. These interest rate movements unrelated to economic fundamentals are particularly interesting in that their analysis will make it possible to study the real effects of monetary policy on real variables (such as GDP). See, for example, one of the pioneering articles on this subject, « Does Monetary Policy Matter? » (Romer & Romer).
Julien P.
