Does Monetary Policy Matter? A New Test In The Spirit Of Friedman And Schwartz

Written By: Christina D. Romer and David H. RomerPresented By: A.J. Andolino, Jim Larson, Trevor Feltz

Introduction

● Does Monetary policy have significant effects on the economy?

● Reanalysis of A Monetary History by Friedman & Schwartz (1963)

● The Narrative Approach○ Specific Disturbance Classification○ Statistical analysis

● Were their interwar conclusions correct?

● Do the results of the narrative approach hold true in the post-war era?

Why Reanalyze the Paper?

● A Monetary History has been praised for its findings on the influence of monetary policy

● Romer & Romer wanted to analyze the data with a revised narrative approach

● Unintentional bias may have been present in Friedman & Schwartz’s paper

Friedman & Schwartz

• Define monetary shocks as “a movement that is unusual given economic development”

• Are these shocks negative or positive?

Friedman & Schwartz

● Their approach found four significant economic events in the interwar period.

January-July 1920 Beginning of the Great Depression October 1931 June 1936-January 1937

● They determined that contractionary non-monetary forces such as tax increases or changes in government spending led to these shocks

Two Possible Biases

1. Two interwar economic events were overlooked by Friedman & Schwartz, questioning the validity of their selection process

-1933: Deflationary policy during recession-1941: Reserve rate rises, no apparent shock

2. They may have searched for exogenous shocks during the period when output fell (non-monetary policies)

-Endogenous variables leading the economic shock were overlooked

New Narrative Approach

• Post-war period deemed better than interwar due to a better understanding of monetary policy

• Specified criteria for determining shocks

• Reviewed FOMC minutes to find events where the Fed expressed concern about rising inflation

What Happened After the Shocks?

• After these six shocks in the post war period were identified, Romer and Romer chose two methods to see what happenedo Informal Evidenceo Statistical Test

Informal Evidence

Informal Evidence

Statistical Test

y=change in unemployment rate or log industrial production

D=dummy variable (was there a monetary shock or not)M=monthly dummy variables

Romer & Romer’s Findings

• The effects of the monetary disturbances are very persistent in the post-war era.

• The shocks identified account for much of the post Word War II economic fluctuations.

• Evidence in the interwar era (between World War I and II) suggests that monetary disturbances have large real effects.

• Bias exists in Friedman and Schwartz’s selection of monetary shocks

Empirical Results

Empirical Results

● Fed purposely induced many recessions (Postwar Era)○ Policy led to 12% decrease in production○ 2% increase in unemployment○ 5 years after shock 7% decrease in production can

be found still (highly persistent)● T statistic= -3.4 (statistically significant)

○ Output reduction due to policy not chance● 20% reduction in industrial production due to

monetary disturbances (Interwar era)● Real effects found between WWI-WWII not persistent

○ 33 months economy back to previous path

Conclusions

❖Monetary Policy has large real effects in both periods but persistence of those real effects varies between the inter and post war

❖ Friedman and Schwartz’s results hold true with new narrative approach