Modest Policy Interventions

Eric M. Leeper and Tao Zha
Working Paper 2003-24
October 2003

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The authors present a theoretical and empirical framework for computing and evaluating linear projections conditional on hypothetical paths of monetary policy. A modest policy intervention does not significantly shift agents’ beliefs about policy regime and does not induce the changes in behavior that Lucas (1976) emphasizes. Applied to an econometric model of U.S. monetary policy, the authors find that a rich class of interventions routinely considered by the Federal Reserve is modest and their impacts can be reliably forecast by an identified linear model. Modest interventions can shift projected paths and probability distributions of macro variables in economically meaningful ways.

JEL classification: E52; E47; C53

Keywords: monetary policy, identification, forecasting, policy analysis, Lucas critique

The authors thank an anonymous referee, Ralph Bryant, Peter Clark, Tom Cooley, Jon Faust, John Geweke, Ross Levine, Adrian Pagan, Peter Pedroni, Tom Sargent, Ellis Tallman, Anders Vredin, Mike Woodford, and especially David Gordon, Chris Sims, and Dan Waggoner for helpful suggestions. This paper was presented at the Monetary Policy and Learning Conference sponsored by the Federal Reserve Bank of Atlanta in March 2003. The views expressed here are the authors’ and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors’ responsibility.

Please address questions regarding content to Eric Leeper, Department of Economics, Indiana University, 304 Wylie Hall, Bloomington, Indiana 47405,, or Tao Zha, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street, N.E., Atlanta, Georgia 30309-4470, 404-498-8353,