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Measuring The Effect Of Forward Guidance In Small Open Economies: The Case Of Israel

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  • ARI KUTAI

    (Bank of Israel)

Abstract

In this paper, I measure the effect of forward guidance in a small and open economy, using Israel as a case study. I suggest an alternative approach to the standard method of Gurkaynak et al. (2005) that relaxes the assumption of constant structure and estimates the effect of forward guidance (FG) separately for each shock and term to maturity. Namely, I relax the assumption that the relative effect is fixed across maturities for every FG shock, regardless of the information contained in each FG statement. This approach also controls for global shocks under the assessment that their impact may not be negligible in a small open economy. I find that while the estimates of the shocks from both methods are highly correlated, the standard method leads to imprecise identifications in cases where the FG shocks mainly affect specific terms to maturity. The results suggest that policymakers should take into consideration which term to maturity each FG statement impacts. In addition, I show that some of the main FG statements made by the Bank of Israel significantly affected yields.

Suggested Citation

  • Ari Kutai, 2023. "Measuring The Effect Of Forward Guidance In Small Open Economies: The Case Of Israel," Israel Economic Review, Bank of Israel, vol. 21(1), pages 75-142, March.
    • Handle: RePEc:boi:isrerv:v:21:y:2023:i:1:p:75-142
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    References listed on IDEAS

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    1. Ben S. Bernanke & Kenneth N. Kuttner, 2005. "What Explains the Stock Market's Reaction to Federal Reserve Policy?," Journal of Finance, American Finance Association, vol. 60(3), pages 1221-1257, June.
    2. Claus Brand & Daniel Buncic & Jarkko Turunen, 2010. "The Impact of ECB Monetary Policy Decisions and Communication on the Yield Curve," Journal of the European Economic Association, MIT Press, vol. 8(6), pages 1266-1298, December.
    3. Ben S. Bernanke & Vincent R. Reinhart & Brian P. Sack, 2004. "Monetary Policy Alternatives at the Zero Bound: An Empirical Assessment," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 35(2), pages 1-100.
    4. Donald L. Kohn & Brian P. Sack, 2003. "Central bank talk: does it matter and why?," Finance and Economics Discussion Series 2003-55, Board of Governors of the Federal Reserve System (U.S.).
    5. Kuttner, Kenneth N., 2001. "Monetary policy surprises and interest rates: Evidence from the Fed funds futures market," Journal of Monetary Economics, Elsevier, vol. 47(3), pages 523-544, June.
    6. Nadav Ben Zeev & Christopher Gunn & Hashmat Khan, 2020. "Monetary News Shocks," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 52(7), pages 1793-1820, October.
    7. Swanson, Eric T., 2021. "Measuring the effects of federal reserve forward guidance and asset purchases on financial markets," Journal of Monetary Economics, Elsevier, vol. 118(C), pages 32-53.
    8. Eric T. Swanson, 2011. "Let's Twist Again: A High-Frequency Event-study Analysis of Operation Twist and Its Implications for QE2," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 42(1 (Spring), pages 151-207.
    9. Jeffrey R. Campbell & Jonas D. M. Fisher & Alejandro Justiniano & Leonardo Melosi, 2017. "Forward Guidance and Macroeconomic Outcomes since the Financial Crisis," NBER Macroeconomics Annual, University of Chicago Press, vol. 31(1), pages 283-357.
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    Cited by:

    1. Benchimol, Jonathan & Saadon, Yossi & Segev, Nimrod, 2023. "Stock market reactions to monetary policy surprises under uncertainty," International Review of Financial Analysis, Elsevier, vol. 89(C).
    2. Nimrod Cohen, 2022. "Analysis of the Amplification Mechanisms in the Process of Debt Deleveraging," Bank of Israel Working Papers 2022.16, Bank of Israel.
    3. Benchimol, Jonathan & Gamrasni, Inon & Kahn, Michael & Ribon, Sigal & Saadon, Yossi & Ben-Ze’ev, Noam & Segal, Asaf & Shizgal, Yitzchak, 2022. "The interaction between domestic monetary policy and macroprudential policy in Israel," Economic Modelling, Elsevier, vol. 112(C).
    4. Itamar Caspi & Amit Friedman & Sigal Ribon, 2024. "Shocks and Currents: Monetary Policy and Israel’s Foreign Exchange Market," Comparative Economic Studies, Palgrave Macmillan;Association for Comparative Economic Studies, vol. 66(3), pages 454-481, September.

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    More about this item

    Keywords

    Monetary Policy; Forward Guidance; Small Open Economies;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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