Rising Fed Information Effects


We document expansionary effects on output, unemployment, prices, and investment following contractionary monetary policy in recent samples starting in the 1980s. These puzzling results are mainly driven by the later period beginning in the mid-1990s while results in the earlier sample match classic monetary policy effects. The rising importance of the information channel of monetary policy accounts for this shift in monetary transmission. In recent times, policy rate hikes signal improvements to the economy’s outlook and stimulate activity, outweighing their conventional contractionary effects. We use a model with information frictions to formalize and study each of these effects. In our model, firms interpret changes in the federal funds rate as endogenous signals about the state of the economy, where the strength of the information effect depends on how precisely monetary policy responds to the state of the economy. We also use our model to study the role of alternative communication strategies and conclude that effective communication on the part of the Fed mitigates the information effects.