Ebook The Timing of Monetary Policy Shocks
An important branch of the macroeconomics literature is motivated by the questions of whether, to what extent, and why monetary policy matters. As concerns the first two questions, substantial empirical work has led to a broad consensus that monetary shocks do have real effects on output. Moreover, the output response is persistent and occurs with considerable delay: The typical impulseresponse has output peaking six to eight quarters after a monetary policy shock (see, for example, Christiano, Eichenbaum, and Evans 1999). As for the third question, a large class of theories points to the existence of contractual rigidities to explain why monetary policy might cause real effects on output. Theoretical models usually posit some form of nominal or real rigidity in wages or prices that is constant over time. For example, wage contracts are assumed to be staggered uniformly over time or subject to change with a constant probability at each point in time (Taylor 1980 and Calvo 1983).
This convenient simplification, however, may not be a reasonable approximation of reality. As a consequence of organizational and strategic motives, wage contract renegotiations may occur at specific times in the calendar year. While there is no systematic information on the timing of wage contracts, anecdotal evidence supports the notion of “lumping” or uneven staggering of contracts. For example, evidence from firms in manufacturing, defense, information technology, insurance, and retail in New England surveyed by the Federal Reserve System in 2003 for the “Beige Book” indicates that most firms take decisions regarding compensation changes (base-pay and health insurance) during the fourth quarter of the calendar year. Changes in compensation then become effective at the very beginning of the next year. The Radford Surveys of compensation practices in the information technology sector reveals that more than 90 percent of the companies use a focal base-pay administration, with annual pay-change reviews; pay changes usually take place at the beginning of the new fiscal year. According to the same survey, 60 percent of the IT companies close their fiscal year in December. To the extent that there is a link between pay changes and the end of the fiscal year, it is worth noting that 64 percent of the firms in the Russel 3,000 index end their fiscal year in the fourth quarter, 16 percent in the first, 7 percent in the second, and 13 percent in the third quarter. Finally, reports on collective bargaining activity compiled by the Bureau of Labor Statistics indicate that the distribution of expirations and wage reopening dates is tilted towards the second semester of the year.
If the staggering of wage contracts is not uniform, as the anecdotal evidence seems to suggest, in principle monetary policy can have different effects on real activity at different points in time. Specifically, monetary policy should have, other things equal, a smaller impact in periods of lower rigidity — that is, when wages are being reset. This paper provides an indirect test for the presence and the importance of the lumping or uneven staggering of contracts by examining the effect of monetary policy shocks at different times in the calendar year. In order to do so, we introduce quarter-dependence in an otherwise standard VAR model. Our goal is to assess whether the effect of a monetary policy shock differs according to the quarter in which the shock occurs and, if so, whether such a difference can be reconciled with uneven staggering.
We find that there are significant differences in output impulse-responses depending on the timing of the shock. In particular, after a monetary shock that takes place in the first quarter, the response of output is fairly rapid, with output reaching a level close to the peak effect 4 quarters after the shock.
The response is even more front-loaded and dies out faster when the shock takes place in the second quarter. Then the peak effect is reached 3 quarters after the shock. In both the first and second quarters of the calendar year, the response of output to a monetary policy shock is economically relevant. An expansionary shock in either the first or the second quarter with an impact effect on the federal funds rate of -25 basis points raises output in the following 8 quarters by an average of about 22 basis points. In contrast, the response of output to a monetary shock occurring in the second half of the calendar year is small, both from a statistical and from an economic standpoint. A 25 basis points unexpected monetary expansion in either the third or fourth quarter raises output in the 8 quarters following the shock by less than 10 basis points on average, with the effect not statistically different from zero at standard confidence levels. The well-known finding that output takes a long time to respond and is quite persistent can then be interpreted as the combination of these sharply different quarterly responses.
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