Economic Shocks and the Fed’s Policy--The Transmission Conduit and Its International Linkage

This paper uses a Bayesian Vector Autoregression (BVAR) model to evaluate the impacts of policy and financial shocks on several economic variables.We use both expected federal funds and unexpected federal funds rates as an indicator of monetary policy respectively.In addition to the traditional financial market measures, i.e., bank loan and equity price changes to signal the financial shocks, we introduce a new credit measure that reflects the differential credit access for small and large firms. We use U.S. monthly data from July 1954 to March 2009.The results of our impulse response functions and variance decomposition provide a positive assessment of the Fed’s recent policy actions.We also extend the framework to include four foreign countries and show that foreign stock prices are significantly affected by U.S. equity shock in a later time period, indicating a stronger global integration recently.Nevertheless, the U.S. equity market is not affected much by the foreign equity market.