Are Changes in the Monetary Base More Effective When They Result from a Change in the Central Bank’s Nominal Target?

Over the last few years, the Federal Reserve has increased the monetary base fourfold. Given the Federal Reserve’s dual mandate, the objective of this policy has been to generate an increase in real economic activity while maintaining a low, stable rate of inflation. Some, such as Sumner (2011, 2012) and Woodford (2012) have advocated making the expansion of the monetary base conditional upon a particular target for nominal income. This paper develops a model to examine the effects of exogenous changes in the monetary base and changes to the monetary base that result from exogenous changes to the central bank’s nominal target. The model is estimated using Bayesian estimation. The posterior distribution of impulse response functions suggests that changes in the monetary base that result from changes in the nominal target are larger and more persistent that exogenous changes in the monetary base itself.