Thesis (Selection of subject)

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High Frequency Identification of Monetary Policy Shocks in Sweden

Thesis title in Czech:	Vysokofrekvenční Identifikace monetárních šoků ve Švédsku
Thesis title in English:	High Frequency Identification of Monetary Policy Shocks in Sweden
Key words:	Měnová politika, Švédsko, šoky monetární politiky, úroková sazba, proxy SVAR
English key words:	Monetary policy, Sweden, monetary policy shocks, interest rate, Proxy SVAR
Academic year of topic announcement:	2019/2020
Thesis type:	diploma thesis
Thesis language:	angličtina
Department:	Institute of Economic Studies (23-IES)
Supervisor:	PhDr. Jaromír Baxa, Ph.D.
Author:	hidden - assigned by the advisor
Date of registration:	25.06.2020
Date of assignment:	25.06.2020
Date and time of defence:	26.01.2022 09:00
Date of electronic submission:	17.11.2021
Date of proceeded defence:	26.01.2022
Opponents:	prof. Ing. Evžen Kočenda, M.A., Ph.D., DSc.



URKUND check:

Guidelines

Motivation:
Central banks all over the world use monetary policy to help stimulate the economy. This monetary policy often takes the form of a change in a given interest rate to effectively stimulate the economy or stabilize inflation. For this approach to work, banks need to have an accurate idea of how changes in the banks’ instruments affect different parts of economy.
Disentangling different outcomes and effects of applied instruments is a challenging task. Different variables and economic events come into play and one might have a hard time correctly identifying the causal relationships via traditional methods.
Therefore, in recent years, a new strand of literature tried to utilize a high frequency identification approach with the newly available data to correctly disentangle the effects. By focusing on a short time window around the announcement of monetary policy changes, one should theoretically be able to identify independent surprises that directly impact economic and financial variables. In theory, the applied instruments should be orthogonal to other shocks if we assume that surprises are exogeneous in the examined short time window around central banks’ announcements.
This approach would then allow the policy maker to correctly infer the effects on macroeconomic variables of the applied instruments into the economy. Therefore, this relatively novel approach should be able to provide more clarity on the actual effectiveness of monetary policy and be of a great importance to central banks around the world. Furthermore, this approach provides more evidence on the actual magnitude of effects and can be compared to other traditional methods, such as DSGE models. It can also serve as a first step estimator of the actual parameters which are later utilized in the said models.
Another important part of the proposed topic is that it allows the researcher to simultaneously analyze the dynamic propagation of shocks into multiple parts of the economy. Therefore, one might examine both the response of financial, economic and foreign variables to properly see the interplay and relationships among them.
Multiple studies have already applied a similar methodology in the USA. However, there is still a significant gap in the utilization of said methodology in other countries (such as Cochrane & Piazzesi (2002)). Since the correct estimation requires a creation of synthetic high frequency time series proxied by different instruments (usually financial), the application in smaller European countries is still lacking. While we can find studies focusing on the UK (such as Cesa-Bianchi, et al. (2020)), the case of Sweden is still largely forgotten even though it poses an interesting case of a small open economy with strong ties to its Nordic neighbors and the rest of Europe.

Hypotheses:
1. Utilizing short time spans around central bank’s announcements helps to disentangle monetary policy shocks from other types of effects. In other words, focusing on changes in high frequency data of financial instruments around monetary policy shocks identifies unexpected economy and market reactions.
2. Monetary policy tightening has a real impact on economic and financial variables, i.e. reducing the economic activity, reducing inflation or raising unemployment.
3. Monetary policy shocks in a small open economy (Sweden) transmit into other countries (Norway, Denmark, etc.).
Methodology:
The main methodology of the proposed thesis revolves around the utilization of Proxy-SVAR. Approach is mainly inspired by Stock and Watson (2012) and Mertens and Ravn (2013). The method uses the surprises as instruments for monetary policy shocks to isolate the variation in VAR residuals due to structural shocks of interest. The important assumption is that the surprises are independent of other economic events or variables. This allows us the focus on short time windows around the announcements.
In theory, dataset of intra-day data captures changes in expectation about the monetary policy stance in the country. These changes are proxied by interest rate futures changes 30 minutes around the announcements.
One issue with this approach is the exogeneity of shocks. Announcements might carry information about the status of the economy and be interpreted by the markets as such. This could violate the orthogonal assumption and negate potential results. Literature suggests that this depends on the nature of the announcements (scheduled vs. unscheduled) and other variables. Evidence and discussion of this will be included in the final paper.
Time series of monetary policy surprises (monetary surprises aggregated at monthly frequency) will be developed according to the methodology proposed by Gertler and Karadi (2015) based on the Swedish Krona Futures contracts settled in March, June, September, and December (3-month, 6-month, etc.) listed on ICE. Source will be Refinitiv Eikon. Announcements published by Sveriges Riksbanks are available on the riksbank.se. They take a form of minutes available. There are about 120 minutes available from 120 meetings dating back 1999. Generally, there are 6 meetings in any given year.
Other variables included in the final Proxy-SVAR model will be variables related to economy (CPI, unemployment rate, GDP growth, nominal effective exchange rate, etc.) and financial markets (corporate bond spreads, mortgage spreads, credit index, etc.). To explore the small economy paradigm, bond spreads from other countries will also be included. Sources for these will be, again, Refinitiv Eikon and Eurostat.
Various robustness checks will be also included. This will include interest rate futures at different maturities, varying the number of lags in the final model or experimenting with different confidence bands calculations. Optimal conduction of robustness checks should ensure that the results of the thesis are presentable and grounded in theory & evidence.

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Preliminary scope of work

Expected Contribution:
The thesis should contribute with novel evidence on real dynamic impacts of monetary policy shocks in Sweden on both the economic and financial variables. Important result of the thesis will also be in presenting evidence on transmission of shocks within the economy and within countries close to Sweden, such as Norway or Denmark. Results should also include basis for further studies on the actual influence of small open economies on other countries and the first step estimation of parameters that could be later included in DSGE models.
Contribution of this paper will be also in comparison to other methods already conducted in other countries, or in Sweden and mainly with similar methods employed in other countries, such as UK or USA. Do the results differ or are they in line with the current literature?

Outline:
1. Introduction – introduction of the main motivation for the thesis and why the topic is interesting
2. Literature Review – summary of current literature on the topic of high frequency identification coupled with evidence on estimation of monetary policy effects by traditional methods. International focus.
3. Methodology – introduction to the methodology and theory behind the employed approach (Proxy-SVAR)
4. Data – summary of the data used and description of the methods to create some of the synthetic time series developed
5. Results – presenting the main results of the thesis (special focus on impulse responses) and their main implications
6. Robustness checks – comparison of the results with different methods/inputs to confirm the validity of the results
7. Discussion – results in light of some of the critique presented in the literature
8. Further study – further possible strands of research stemming from the results of the thesis
9. Conclusion – concluding the results and putting all previous chapters together

Preliminary scope of work in English