The Effect of Monetary Policy Shocks on the Inflation Expectation Term Structure: An Empirical Study

This thesis investigates the impact of Fed’s monetary policy shocks — distinguishing between their pure and information components — on the U.S inflation expectations term structure, using a Local Projection framework. Relying on High frequency identification around Federal Open Market Committee (FOMC) announcements, a pure monetary policy shock raises interest rates and depresses stock prices while an information shock, reflecting a more optimistic central bank outlook, increases both interest rates and stock prices. The analysis reveals that market respond to both types of shocks, but with different transmission dynamics. While pure monetary policy shocks, unexpected changes in policy rates, exert a deflationary impact on inflation expectations, information shocks, which arise when central bank announcements convey new assessments of the economic conditions, tend to increase them. Both responses weaken as the maturity horizon increases, suggesting a degree of anchoring in long-term expectations. Furthermore, by adopting a nonlinear model that accounts for the sign of the shock, the results highlight an asymmetric impact of monetary policy, with tightening exerting a stronger and more persistent influence than easing. These findings provide new insights into the transmission of monetary policy and the role of central bank communication in shaping inflation expectations.