The Asymmetric Effects of Monetary Policy: A Nonlinear Vector Autoregression Approach

Article excerpt

This paper investigates whether monetary policy has "asymmetric" effects on output and prices using a nonlinear vector autoregression approach. The model that is estimated is consistent with a wide variety of structural models, in particular, models incorporating asymmetric nominal rigidity. Impulse response functions generated by this model are used to shed light on three questions that have been the focus of a great deal of research in recent years: do positive and negative monetary shocks have asymmetric effects? do the effects of monetary shocks vary over the business cycle? do the effects of monetary shocks vary disproportionately with the size of the shock? Methodologically, the paper extends the literature on nonlinearities in univariate time series to the multiple equation case.(1)

A number of economic theories imply that monetary policy may have asymmetric effects. Morgan (1993) argues that asymmetry is a feature of many widely accepted economic models, including the standard Keynesian model with "Keynesian" and "Classical" regions of the aggregate supply curve, the liquidity trap theory, credit constraint models, and menu cost models. Kandil (1995) points to asymmetric wage indexation and price adjustment as possible causes of asymmetric effects of monetary policy. Asymmetric "real" rigidities such as irreversibility of investment (see, for example, Abel and Eberly 1994) may also be a source of asymmetry.

The evidence for asymmetry in the effects of monetary shocks is mixed. Cover's (1992) finding that positive and negative monetary shocks have asymmetric effects was supported by DeLong and Summers (1988), Morgan (1993), Kandil (1995), Karras (1996), and Thoma (1994). On the other hand, Ravn and Sola (1996) find that positive and negative monetary shocks have symmetric effects once the regime shift in monetary policy in 1979 is controlled for. Garcia and Schaller (1995) find that monetary shocks have stronger effects during recessions than booms, although Evans (1986) finds no evidence for this type of asymmetry. Thoma (1994) finds that negative monetary shocks have stronger effects on output during high-growth periods than low-growth periods, while the effects of positive monetary shocks do not vary over the business cycle. Ravn and Sola (1996) find evidence for asymmetry in the effects of large versus small monetary shocks.

This paper uses a more general approach to modeling asymmetry than that used in the papers cited above. Cover (1992), Kandil (1995), DeLong and Summers (1988), Morgan (1993), and Thoma (1994) estimate reduced-form output equations that can be interpreted as threshold autoregressions where the switching variable is the money supply or the unanticipated component of the money supply. Many other choices of switching variable can be defended on the basis of economic theory, however. This paper follows Beaudry and Koop (1993) and Thoma (1994) in using the economy's position in the business cycle (here proxied by the growth rate of real output) as a switching variable. The change in the inflation rate is also considered. In addition, other studies allow the coefficient on the monetary variable to change in response to realizations of the switching variable, but constrain coefficients on other variables to be constant. This paper constructs a simple aggregate demand--aggregate supply model in structural form and shows that in general such a model will have a reduced form in which all coefficients vary across realizations of the switching variable. The approach used here allows for this more general pattern of switching. Finally, the model estimated in this study allows for a smooth transition between regimes, whereas previous studies assume discrete regime shifts.

The paper makes three contributions to the literature on the asymmetric effects of monetary policy. First, it demonstrates that structural models incorporating asymmetry may suggest different choices of switching variables than those used in previous studies, and require more coefficients to be subject to switching in the reduced form. …