DP11801 The effects of quasi-random monetary experiments

Author(s): Òscar Jordà, Moritz Schularick, Alan M. Taylor
Publication Date: January 2017
Date Revised: November 2017
Keyword(s): fixed exchange rates, instru- mental variables, interest rates, local average treatment effect, local projections, monetary experiments, trilemma
JEL(s): E01, E30, E32, E44, E47, E51, F33, F42, F44
Programme Areas: Economic History, International Macroeconomics and Finance, Monetary Economics and Fluctuations
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=11801

The trilemma of international finance entails that fluctuations in interest rates for countries with fixed exchange rates that allow unfettered cross-border capital flows are mostly due to international arbitrage. Consequently, we can locate a valid source of exogenous variation to identify monetary policy effects with instrumental variable methods. Paired with conventional instruments based on central bank staff forecasts, and using historical data since 1870, we estimate local average treatment effects (LATE) of monetary policy interventions for different subpopulations. Using a novel control function approach we determine the robustness of our findings to possible spillovers via alternative trade-based channels. Our results reveal and rectify attenuation bias in previous estimates, are consistent with theory, and provide a good approximation to the ATE. The effects that we report are quantitatively important and state-dependent.