Decomposing the Monetary Policy Multiplier

Financial markets play an important role in generating monetary policy transmission asymmetries in the US. Credit spreads only adjust to unexpected increases in interest rates, causing output and prices to respond more to a monetary tightening than to an expansion. At a one year horizon, the ‘financial multiplier’ of monetary policy—defined as the ratio between the cumulative responses of employment and credit spreads—is zero for a monetary expansion, -2 for a monetary tightening, and -4 for a monetary tightening that takes place under strained credit market conditions. These results have important policy implications: the central bank may inadvertently over-tighten in times of financial uncertainty.