A. Lee Smith 
Working Papers

Welcome Working Papers Academic Publications FRB-KC Publications CV



The Term Structure of Monetary Policy Uncertainty (with Brent Bundick and Trenton Herriford)
Posted February 2022


In this paper, Brent, Trenton, and I study the transmission of Federal Reserve communication to financial markets and the economy using new measures of the term structure of policy rate uncertainty. Movements in the term structure of interest rate uncertainty around FOMC announcements cannot be summarized by a single measure but instead are two dimensional. The two monetary policy uncertainty factors we derive sbetter explain changes in Treasury yields and forward real interest rates around FOMC announcements. Our policy uncertainty factors also provide stronger first-stage instruments in a proxy SVAR setting which implies more expansionary macroeconomic effects of forward guidance than those estimated only using the expected path of policy rates.

A New Approach to Integrating Expectations into VAR Models (with Taeyoung Doh)
Revised February 2022 (Previously titled: Reconciling VAR-based Forecast with Survey Forecasts)

In this paper, Taeyoung and I propose a Bayesian approach to integrating expectations, as measured by forecasts from surveys, into a VAR model that includes realized values of the same or a closely related variable. We leverage the fact that VARs themselves have the ability to generate a forecast for any variable included in the model. Then, using this VAR-implied forecast together with the survey forecast, we argue for constructing a non-degenerate prior for VAR coefficients that places greater mass on areas of the parameter space where the two forecasts align. We call this the forecast consistent prior. In the latest draft, we show through Monte Carlo simulations that the forecast consistent prior remarkably improves the ability of structural VAR model to recover forward guidance shocks identified using sign restrictions. We also apply the forecast consistent prior to study the role that inflation expectations played in shaping inflation tail-risks during the Great Recession and its aftermath.


The Financial Market Effects of Unwinding the Federal Reserve's Balance Sheet (with Victor J. Valcarcel)
Revised January 2022


In this paper, Vic and I analyze the financial market effects of balance sheet normalization based on the U.S. experience between 2017 and 2019. We find evidence that unwinding past asset purchases tightens financial conditions. However, we show that these effects cannot be merely characterized as quantitative easing in reverse. In particular, we find that balance sheet normalization lacked the large announcement effects that accompanied quantitative easing announcements. Instead, the effects of normalization manifested upon implementation and surfaced, in part, through larger liquidity effects than were evident during various phases of balance sheet expansion.

Did the Federal Reserve Break the Phillips Curve? Theory and Evidence of Anchoring Inflation Expectations (with Brent Bundick)
Revised September 2021 (Previously titled: Does Communicating a Numerical Inflation Target Anchor Inflation Expectations? Evidence & Bond Market Implications)

Media Coverage: MNI Article

In this paper, Brent and I derive two testable predictions from the anchoring of inflation expectations in a macroeconomic model with drifting long-run inflation expectations. First, after anchoring, expectations about inflation far in the future should no longer respond to news about current inflation. Second, better-anchored inflation expectations weaken the relationship between unemployment and inflation, flattening the reduced-form Phillips curve. We evaluate both predictions and find that communication of a numerical inflation objective better anchored inflation expectations in the United States but failed to anchor expectations in Japan. Moreover, the improved anchoring of U.S. inflation expectations can account for much of the observed flattening of the Phillips curve.

Forward Guidance, Monetary Policy Uncertainty, and the Term Premium (with Brent Bundick and Trenton Herriford)
Revised February 2021


In this paper, Brent, Trenton, and I examine the macroeconomic and term-premia implications of monetary policy uncertainty shocks. We employ the VIX methodology to measure implied volatility about future short-term interest rates using options on Eurodollar futures at various horizons. We identify monetary policy uncertainty shocks using the unexpected changes in implied volatility around monetary policy announcements. Two principal components succinctly characterize these changes around policy announcements, which have the interpretation as shocks to the level and slope of the term structure of implied interest rate volatility. We find that an unexpected decline in the slope of implied volatility lowers term premia in longer-term bond yields and leads to higher economic activity and inflation. Our results suggest that forward guidance about future monetary policy can materially affect bond market term premia, even without large-scale asset purchases.

Should We Be Puzzled by Forward Guidance? (with Brent Bundick)
Revised April 2020


In this paper, Brent and I use a range of vector autoregression models to quantify how much output responds to changes in interest rate expectations following a monetary policy shock. Despite distinct identification strategies and sample periods, we find surprising agreement regarding this elasticity across empirical models. We then show that in a standard model of nominal rigidity estimated using impulse response matching, forward guidance shocks produce an elasticity of output with respect to expected interest rates similar to our empirical estimates. Our results suggest that standard macroeconomic models do not overstate the observed sensitivity of output to expected interest rates.