We employ real-time data available to the US monetary policy makers to estimate a Taylor rule augmented with a measure of financial uncertainty over the period 1969–۲۰۰۸٫ We find evidence in favor of a systematic response to financial uncertainty over and above that to expected inflation, output gap, and output growth. However, this evidence regards the Greenspan–Bernanke period only. Focusing on this period, the “risk-management” approach is found to be responsible for monetary policy easings for up to 75 basis points of the federal funds rate.

Introduction

“[…] The Federal Reserve’s experiences over the past two decades make it clear that uncertainty is not just a pervasive feature of the monetary policy landscape; it is the defining characteristic of that landscape. […] the conduct of monetary policy in the United States has come to involve, at its core, crucial elements of risk management’’. Greenspan (2004) Does the Federal Reserve act as a risk-manager? The quote by Former Federal Reserve’s chairman Alan Greenspan points to a positive answer. This paper provides empirical support to this view by quantifying the implications of this ‘‘risk management’’ approach for the federal funds rate. We do so by estimating a Taylor rule augmented with a measure of financial uncertainty over the period 1969M1–۲۰۰۸M10, and by computing the ‘‘riskmanagement-driven policy rate gap’’. This gap measures the difference between the actual policy rate and the counterfactual policy rate that would have been observed had the Federal Reserve not acted as a ‘‘risk manager’’, i.e., had it not reacted to fluctuations in financial uncertainty. Our estimates focus on the entire sample as well as on subsamples identified by changes of the Federal Reserve’s chairman to take into account possible breaks in policymakers’ preferences both over risk management and over inflation and output stabilization (Clarida et al., 2000; Lubik and Schorfheide, 2004; Castelnuovo and Fanelli, 2015; Boivin and Giannoni, 2006; Castelnuovo and Surico, 2010). Importantly, we employ data available in real-time to the Federal Open Market Committee, which is crucial to correctly characterize monetary policy decisions by the Federal Reserve (Orphanides, 2001, 2002; Coibion and Gorodnichenko, 2011, 2012; Gnabo and Moccero, 2015). We find significant evidence in favor of a systematic monetary policy response to movements in financial uncertainty. However, this evidence is limited to the Great Moderation period characterized by the lead of Greenspan and Bernanke. The GreenspanBernanke risk management approach is associated to a looser monetary policy with respect to the one the Federal Reserve would have implemented had it not reacted to financial uncertainty directly. The estimated median value of the ‘‘risk-management-driven’’ policy rate gap is 30 basis points, which is approximately a standard policy rate move. However, in correspondence to well-identified historical events (Black Monday, 2008 credit crunch), such a gap is estimated to be three times as large due to the higher realizations of financial uncertainty. Many empirical proxies of uncertainty have recently been proposed by the literature (for a survey, see Bloom, 2014).