Changing Perceptions and Post-Pandemic Monetary Policy

Speaker: Michael Bauer, Federal Reserve Bank of San Francisco

Organizers: Kiel Institute for the World Economy, CEPR

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Abstract: We document that the Fed's perceived policy response to inflation shifted materially in the post-pandemic period. In a forward-looking monetary policy rule estimated from surveys of macroeconomic forecasts, the inflation coefficient rose significantly after liftoff from the zero lower bound in March 2022. Consistent with this survey evidence, event studies of financial data shows that interest rates became significantly more sensitive to core CPI surprises following liftoff, suggesting an increased responsiveness of expected future policy rates to inflation news. The increase in the perceived inflation response likely aided the transmission of monetary policy to the real economy and improved the inflation-unemployment tradeoff faced by the Federal Reserve. The timing of the increase in the perceived inflation response, as well as other evidence from surveys and financial markets, suggests that forecasters and markets were uncertain about the monetary policy rule prior to liftoff and learned about the Fed's reaction function from observing rate hikes.