Identification of Monetary Policy Shocks with External Instrument SVAR

We explore the use of external instrument SVAR to identify monetary policy shocks. We identify a forward guidance shock as the monetary shock component having zero instant impact on the policy rate. A contractionary forward guidance shock raises both future output and price level, stressing the relative importance of revealing policymakers’ view on future output and price level over committing to a policy stance. We also decompose nonmonetary structural shocks, and find that positive shocks to output and price level lead to monetary contraction. Since information on output and price level is revealed through both monetary and non-monetary channels, some monetary and non-monetary shocks can look alike, leading to linear dependence and violating usual instrument SVAR assumptions. We show that some of the main findings are robust to such dependence. ∗E-mail: [email protected]. I thank Arsenios Skaperdas for helpful comments. The paper expresses solely my own views, not those of the Federal Reserve Board or the Federal Reserve System.