Events

Monetary policy shocks affect interest rates at long horizons (10 years or more). Furthermore, the private sector’s real GDP forecasts are revised upward in response to a monetary tightening. These facts challenge the prevailing theories in academic and policy circles, which are based on the paradigm that monetary policy has limited long-run effects and a monetary policy tightening should depress agents’ beliefs about real GDP. In this paper, I propose a micro-founded model to rationalize those facts, based on the information channel of monetary policy. I consider a framework where the central bank has private information about future economic conditions. Agents update their beliefs according to Bayes’ theorem. Policy actions play a signaling role, and may therefore have an impact on both short and long-term interest rates. Finally, I discuss the implications of information frictions for the design of optimal simple rule.