Are the effects of monetary policy larger in recessions? A reconciliation of the evidence

This paper investigates whether there are significant differences in the response of U.S. output to monetary policy shocks in expansions vs. recessions. Much of the existing literature has found that monetary policy shocks have larger effects during recessions. However, recent influential work by Tenreyro and Thwaites (2016) finds the opposite result, and leaves the literature on this important question with a lack of consensus. Using the empirical framework of Tenreryo and Thwaites (2016) as a baseline, we provide a systematic exploration for the key drivers of differing results regarding the effects of monetary policy shocks over the business cycle. We find two key elements drive the results, the first being whether the local projection impulse response function estimator is conducted in levels vs. long differences of the data, and the second being the treatment of outliers observed in measures of monetary policy shocks during the Volcker disinflation. We conclude that the evidence is more supportive of monetary policy shocks having larger effects during recessions.