Title: Has the U.S. economy become less interest rate sensitive
Abstract: Over past three decades, U.S. economy seems to have become less responsive to monetary policy. Slow recoveries followed recessions in 1990-91, 2001, and 2007-09, a contrast to much more rapid recoveries that followed pre-1990 recessions. These slow recoveries occurred despite sizeable monetary accommodation from Federal Reserve, primarily through reductions in short-term interest rates.This article investigates shifts in economy's interest sensitivity by examining how total employment responds to changes in monetary policy. The Federal Open Market Committee (FOMC) has emphasized important link between monetary policy and employment. For example, in September 2012, FOMC announced its intention to provide additional monetary policy accommodation on an open-ended basis that would continue as long as the outlook for labor market does not improve substantially. While this implies a direct transmission channel between monetary policy and employment, empirical analysis in this article suggests aggregate employment has become less responsive to monetary policy in recent decades.The responsiveness of employment to monetary policy could have diminished for three reasons. First, shift could be a result of changing behavior of monetary policy makers. Numerous researchers have characterized monetary policy in past three decades as following an active (systematic) approach compared with passive approach of 1960s and 1970s (Clarida, Gali, and Gertler). Second, shift could be due to innovations in financial markets and changes in governmental regulation of banking industry. Monetary policy works by influencing market interest rates. Studies have suggested that devel-opments in financial markets have weakened relationship between interest rates and firm and consumer activities (Dynan, Elmerndorf, and Sichel). Third, shift could be due to changes within and across industries. For example, changes in relative sizes of industries may affect overall interest sensitivity of economy as interest-sensitive sectors, such as durable goods manufacturing and construction, have contracted, and less interest-sensitive sectors, such as private service-providing sector, have expanded. Supply-side structural shifts occurring within individual industries over past several decades, including changes in technology and capital intensity, may also affect interest sensitivity. And on demand side, each industry's customers may now respond differently to changes in monetary policy.This article finds that key contributors to declining interest sensitivity are structural shifts within industries and a weaker transmission mechanism between short-term interest rates and economy. In particular, two segments of transmission channel appear to have operated with a longer lag since mid-1980s: transmission from shorter-term to longer-term rates and transmission from longerterm rates to employment. Overall, findings suggest decline in economy's interest sensitivity is not due to changes in conduct of monetary policy but rather to structural changes in industries and financial markets.Section I describes interest rate channel of monetary transmission and vector autoregression (VAR) model used to evaluate interest sensitivity. Section II assesses whether declining interest sensitivity is specific to certain industries or more widespread. Section III uses VAR and a structural model to examine three possible sources of declining interest sensitivity.I. The Declining Interest Rate Sensitivity of EmploymentMonetary policy can affect economy through several channels. The most frequently mentioned channel, or transmission mechanism, is interest rate channel. In this channel, an increase in monetary accommodation such as a cut in target federal funds rate leads to a decline in real interest rates if prices are slow to adjust. …
Publication Year: 2015
Publication Date: 2015-03-22
Language: en
Type: article
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Cited By Count: 7
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