DP17133 Identifying Monetary Policy Shocks: A Natural Language Approach

Author(s): Boragan Aruoba, Thomas Drechsel
Publication Date: March 2022
Date Revised: May 2022
Keyword(s): Fed Information Effect, Federal Reserve, Machine Learnings, monetary policy, Natural Language Processing
JEL(s): C10, E31, E32, E52, E58
Programme Areas: International Macroeconomics and Finance, Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=17133

We propose a novel method to identify monetary policy shocks. By applying natural language processing techniques to documents that economists at the Federal Reserve Board prepare for Federal Open Market Committee meetings, we capture the information set available to the committee at the time of policy decisions. Using machine learning techniques, we then predict changes in the target interest rate conditional on this information set, and obtain a measure of monetary policy shocks as the residual. An appealing feature of our procedure is that only a small fraction of interest rate changes is attributed to exogenous shocks. We find that the dynamic responses of macroeconomic variables to our identified shock measure are consistent with the theoretical consensus. We also demonstrate that our estimated shocks are not contaminated by the "Fed information effect."