Changes in Monetary Regimes and the Identification of Monetary Policy Shocks: Narrative Evidence from Canada

We use narrative evidence along with a novel database of real-time data and forecasts from the Bank of Canada’s staff economic projections from 1974 to 2015 to construct a new measure of monetary policy shocks and estimate the effects of monetary policy in Canada. We show that it is crucial to take into account the break in the conduct of monetary policy caused by the announcement of inflation targeting in 1991 when estimating the effects of monetary policy. For instance, we find that a 100-basis-point increase in our new shock series leads to a 1.0 per cent peak decrease in real GDP and a 0.5 per cent fall in the price level, while not accounting for the break leads to a very persistent decrease in real GDP and a price puzzle. Albeit the change in monetary policy regime, we find that the effects of monetary policy have not changed much before and after IT. Finally, we compare our results with narrative evidence for the U.S. and the U.K. and find slightly stronger effect of monetary policy on output and significantly smaller effects on the price level in Canada.