Barakchian and Crowe (2013) measured US monetary policy shocks from changes in federal funds futures prices in a window around Federal Open Market Committee announcements (October 1988–2008), extracting two factors, and recovered a strong contractionary output effect but a persistent positive medium-run price response — the price puzzle — whose origin they left open, together with the validity of the identification assumptions behind futures-based surprises. The subsequent literature broadly diagnoses the price puzzle as an identification artifact of announcement-window contamination (the Fed information effect, central bank information shocks, and the Fed's predictable response to public news), Swanson's (2021) three-factor measures supersede the two-factor extraction question, and the pre-1988 extension is data-bound rather than open. The surviving open core is the decomposition itself: separating the genuine policy shock component of futures-based surprises from central-bank private information, the Fed's predictable response to already-public macroeconomic news, and time-varying risk/term premia — and establishing the corrected causal responses of prices and output. Competing corrections (Jarociński–Karadi, Miranda-Agrippino–Ricco, Bauer–Swanson) rest on different views of the contamination and still deliver different corrected series and transmission estimates.

Background

A central empirical question in monetary economics is how much, and how fast, an unanticipated change in monetary policy moves output and prices. Because the Federal Reserve sets the federal funds rate (the overnight interbank lending rate that is its operating target) in response to economic conditions, raw interest-rate movements mix together the Fed's systematic reactions with genuine policy surprises, so vector autoregressions (VARs, systems of regressions of each variable on lags of all variables) identified by recursive ordering often found the counterintuitive result that a policy tightening is followed by higher rather than lower prices — the 'price puzzle', which casts doubt on the identification rather than on monetary theory itself. The narrative approach of Romer and Romer (2004) purged the policy rate of the Fed's systematic responses to its own forecasts; high-frequency identification (HFI) instead measures surprises directly from financial markets. Federal funds futures (contracts whose payoff is tied to the average realized funds rate in a future month, traded on the Chicago Board of Trade since October 1988) embed market expectations of the policy rate, so, following Kuttner (2001), the change in futures prices in a narrow window around a Federal Open Market Committee (FOMC, the Fed's rate-setting committee) announcement isolates the unanticipated component of the policy action. Gürkaynak, Sack and Swanson (2004) showed that these announcement-window reactions are well summarized by a 'target' factor (the surprise in the current setting) and a 'path' factor (the surprise about future policy). Barakchian and Crowe (2013) built exactly such a two-factor futures-based shock series for 1988–2008, showed that earlier identification schemes break down in the post-1988 sample (where standard VARs produce expansionary output responses and a pervasive price puzzle), and found with their measure a large contractionary output effect — about half of output variation at business-cycle horizons — but a positive medium-run price response that survived adding commodity prices and short-horizon inflation expectations. Their identification, however, assumes that risk/term premia (the compensation investors demand for holding futures beyond pure expectations, which if it moved predictably around announcements would contaminate the surprise) do not change predictably around announcement days, that no other macroeconomic news moves expectations inside the event window, and that announcements do not systematically reveal information possessed only by the Fed; futures-based surprises have since become the standard 'external instrument' (proxy SVAR) input for the monetary policy shock, used by Gertler and Karadi (2015) and much of the subsequent literature, which makes the validity of these assumptions a first-order question for empirical monetary economics. The modern debate names the candidate contaminants: the Fed information effect (Nakamura and Steinsson, 2018) — announcements convey the Fed's private assessment of the economy, so a tightening can raise expected output and inflation; central bank information shocks (Jarociński and Karadi, 2020) — identified from the high-frequency co-movement of interest rates and stock prices; the Fed's predictable response to public news (Bauer and Swanson, 2022) — surprises correlate with macro-financial data released before the announcement; and time-varying risk premia (Miranda-Agrippino). How much of a futures-based surprise is policy, how much is revealed information, how much is predictable reaction to public data, and what the corrected causal effects of monetary policy on prices and output are, remains contested.

Problem Statement

For US monetary policy surprises measured from federal funds futures price changes in a window around FOMC announcements (the Barakchian–Crowe measure and its high-frequency descendants), determine what the measured surprise actually contains and what the true causal effects of monetary policy are. Concretely: (i) decompose announcement-window futures-based surprises into the genuine monetary policy shock component and the contaminating components arising from central-bank private information revealed by the announcement (the Fed information effect / central bank information shocks), the Fed's predictable response to macroeconomic and financial data already public before the announcement, and time-varying risk/term premia in futures prices; (ii) given that the 2018–2021 literature broadly diagnoses the positive medium-run price response found by Barakchian and Crowe (2013) — the price puzzle that survived controls for commodity prices and short-horizon inflation expectations — as an artifact of announcement-window contamination rather than a genuine positive price effect of tightening, determine which of these contaminating components, if any, produces it, and how the corrected price response depends on the correction adopted; (iii) determine whether the third identifying assumption on which the Barakchian–Crowe measure rests — that the policy announcement itself should not reveal information about the Fed's private information set or its reaction function, on which the authors report the evidence as 'more mixed' than on their other assumptions — holds, and what any such contamination implies for the estimated responses of output and prices. In the authors' own decomposition, the shock measure reacts positively to the Fed's private forecasts of near-term output and inflation, yet the private information set explains less than 19 percent of the measure (the joint null of zero coefficients on all 17 variables in it cannot be rejected, p-value 0.13); in their fitted/residual decomposition both components have negative output effects of strikingly similar magnitude, the fitted portion accounting for about 17 percent and the residual portion for about 30 percent of output variation at a three-year horizon; and they conclude that the resulting simultaneity bias attenuates the estimated impulse responses toward zero — so the contractionary output effect may be an underestimate — while 'appear[ing] to be small under our identification scheme'. The scope is that of the source measure: fed funds futures traded only from October 1988, and the source's estimates run from December 1988 to June 2008, deliberately ending before the post-Lehman intensification of the financial crisis, which likely represents a significant structural break; the post-2008 effective-lower-bound period lies outside the scope of the source measure. Two sub-questions raised by the source are already settled and provide context rather than open scope: three, not two, factors are needed to summarize announcement-window reactions (Swanson 2021), and no futures-based series can exist before October 1988, when the market began trading.

References

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