Hyst JST Aug2019

The long-run effects of monetary policy ?
Òscar Jordà † Sanjay R. Singh ‡ Alan M. Taylor §
August 2019
Preliminary draft
Abstract
A well-worn tenet holds that monetary policy does not affect the long-run productive
capacity of the economy. Merging data from two new international historical databases,
we find this not to be quite right. Using the trilemma of international finance, we find
that exogenous variation in monetary policy affects capital accumulation, and to a lesser
extent, total factor productivity, thereby impacting output for a much longer period of
time than is customarily assumed. These results are robust to sample cuts, accounting
for structural breaks in TFP growth, spillovers across countries, and miscellaneous
robustness checks. Monetary policy can have long-run effects.
JEL classification codes: E01, E30, E32, E44, E47, E51, F33, F42, F44
Keywords: monetary policy, interest rates, money neutrality, potential output, hysteresis,
trilemma, instrumental variables.
? We are thankful to Gadi Barlevy, Susanto Basu, James Cloyne, John Fernald, Jordi Gali, Yuriy Gorod-
nichenko (discussant), Pierre-Olivier Gourinchas, Ina Simonovska, and many seminar and conference par-
ticipants at Barcelona Summer Forum, NBER Summer Institute - IFM, SED, Federal Reserve Bank of San
Francisco, Federal Reserve Board of Governors, Midwest Macro, UC Davis who provided very helpful com-
ments and suggestions. Antonin Bergeaud graciously shared detailed data from the long-term productivity
database created with Gilbert Cette and Rémy Lecat at the Banque de France. All errors are ours. The views
expressed in this paper are the sole responsibility of the authors and to not necessarily reflect the views of the
Federal Reserve Bank of San Francisco or the Federal Reserve System.
† Federal Reserve Bank of San Francisco; and Department of Economics, University of California, Davis
(oscar.jorda@sf.frb.org; ojorda@ucdavis.edu).
‡ Department of Economics, University of California, Davis (sjrsingh@ucdavis.edu).
§ Graduate School of Business and Department of Economics, University of California, Davis; National
Bureau of Economic Research; and Center for Economic Policy Research (amtaylor@ucdavis.edu).
When coin is in greater plenty, as a greater quantity of it is required to represent the
same quantity of goods, it can have no effect either good or bad, taking a nation within
itself, any more than it would make an alteration in a merchant’s books; if instead of
the Arabian method of notation, which requires few characters, he should make use of
the Roman, which requires a great many.
— Of Money in Hume (1758)
1. Introduction
Money has long been believed to be neutral in the long-run, as David Hume noted, and as a
voluminous literature on monetary economics has argued more formally with rare exceptions.1
However, the evidence is less clear cut than the elegant logic of the predominant theories would
suggest. Barro (2013) provides evidence that high levels of inflation result in a loss in the rate of
economic growth. Work by Caballero, Hoshi, and Kashyap (2008) and Gopinath, Kalemli-Özcan,
Karkarabounis, and Villegas-Sánchez (2017) links interest rates to the level of productivity, whereas
more recently, Benigno and Fornaro (2018) and Liu, Mian, and Sufi (2018) link low interest rates
with the rate of growth of productivity. Our paper follows in this more recent tradition and sets out
to investigate the link between monetary policy, the growth rate of productivity, and the growth rate
of output in the medium to long term.
In monetary economics, most theories embrace the assumption that an exogenous shock to
interest rates has only transitory effects on prices and economic activity (see, e.g., Christiano,
Eichenbaum, and Evans, 1999; Ramey, 2016; Coibion, Gorodnichenko, and Ulate, 2017). However,
recent research by Jordà, Schularick, and Taylor (2019) suggests that previous measures of monetary
shocks might have been endogenous responses to the outlook. They introduce a new instrumental
variable based on the trilemma of international finance (see, e.g., Obstfeld, Shambaugh, and Taylor,
2004, 2005; Shambaugh, 2004) to document that monetary shocks have larger and more persistent
effects than previously measured, and closer in magnitude to measures obtained with narrative
shocks (Romer and Romer, 2004) and market-based, high-frequency identified shocks (Gertler and
Karadi, 2015). Moreover, they also document that the effects of monetary policy are state-dependent,
extending similar results reported in Tenreyro and Thwaites (2016), Angrist, Jordà, and Kuersteiner
(2018), and Barnichon and Matthes (2018).
Using the same instrument as Jordà, Schularick, and Taylor (2019) we show, using historical data
since 1870 on 17 advanced economies, that monetary shocks have very long-lasting effects on output
and productivity. In particular, we augment the data in Jordà, Schularick, and Taylor (2017) and
available at www.macrohistory.net/data, with data on total factor productivity (TFP) and factor
input from Bergeaud, Cette, and Lecat (2016) and available at http://www.longtermproductivity.
com.2
1 See, for example, the discussion of Sidrauski’s work by Fischer (1983).
2 We are particularly thankful to Antonin Bergeaud for sharing some of the disaggregated series from
their database that we used to construct our own series of adjusted TFP.
1
We investigate this proposition from a variety of angles, by correcting for spillover effects,
considering different samples, and examining state dependence as a function of the business cycle,
the level of inflation, and importantly, credit. We also examine the soundness of our findings to
alternative definitions of monetary shocks based on Romer and Romer (2004) for the postwar United
States. The main result is robust to all these modifications. We then look under the hood to examine
through what channels is monetary policy exacting these changes on output growth. We find that the
total hours worked response is relatively stable and small. Thus, the main effects on output growth
that we uncover appear to come primarily through the responses of real capital accumulation, and to
a lesser extent, of utilization adjusted TFP. These results echo the important early findings by Evans
(1992) who cast doubt on the exogeneity of TFP shocks, a key tenet of mainstream DSGE models,
finding that money, interest rates, and government spending Granger-caused these impulses.
Motivated by these findings, we build a quantitative medium-scale DSGE model with endoge-
nous TFP growth to understand the mechanisms at work and spell out policy implications. TFP
growth deviates from the exogenous trend in response to monetary shocks whenever output is
different from potential output. A contractionary monetary policy shock lowers output temporarily
producing a slowdown in TFP growth. Under a standard Taylor rule, the temporary slowdown
in TFP growth accumulates to yield permanently lower trend levels of output and capital. The
model can generate this medium run effect on GDP while replicating the conventional textbook
results, namely the utilization rates of labor and capital fall temporarily, and capital to TFP ratio
exhibits a hump-shaped response. In our empirical analysis, we corroborate these conventional
results (Christiano, Eichenbaum, and Evans, 2005) for the historical sample.
Our paper is related to the seminal work by Cerra and Saxena (2008) who documented that output
losses in the aftermath of economic and political crises in low-income and emerging economies
are highly persistent. More recently, researchers have also documented similar effects following
financial crises for advanced economies (see Martin, Munyan, and Wilson, 2015; Haltmaier, 2013).
Duval, Hong, and Timmer (2019) find cross-country firm-level evidence for slowdown in TFP growth
caused by adverse credit conditions during the global financial crisis. Fatás and Summers (2018)
document strong hysteresis effects of fiscal consolidations for advanced economies following the
global financial crisis. Over the much longer run, we document a causal effect of monetary policy
shocks in a historical panel data for advanced economies.
There is mixed evidence of long-run non-neutrality proposition in monetary economics. In
the structural VAR literature, Bernanke and Mihov (1998) fail to reject long-run neutrality in
their identified responses to monetary policy shocks since the impulse responses are statistically
indistinguishable from zero. Mankiw (2001) however interprets the non-recovery of GDP to zero in
Bernanke and Mihov (1998)’s point estimates as evidence of long-run non-neutrality.
Our paper is also related to the recent literature that emphasizes slow recovery following the
Great Recession due to endogenous productivity growth (Anzoategui, Comin, Gertler, and Martinez,
2018; Bianchi, Kung, and Morales, 2019), labor force participation (Erceg and Levin, 2014; Galı́, 2016),
or skill depletion (Kiyotaki and Zhang, 2017). This literature has its origins in the seminal work by
2
Stadler (1990) who developed a business cycle model with endogenous technology and sticky wages
to generate a persistent effect of monetary shocks on output.3 Of the recent papers, Moran and
Queraltó (2018) use three-equation VAR models to emphasize an empirical link between TFP growth
and monetary policy shocks. We differ in two important ways. One, we investigate and establish
that monetary policy shocks can affect level of GDP, capital stock as well as TFP in a panel of 17
countries spanning more than a hundred years. Two, we use externally identified shocks instead of
ordering restrictions to identify monetary policy shocks.
Our analysis further provides answer to questions raised by policymakers including Chair Yellen
(2016) recently:
Are there circumstances in which changes in aggregate demand can have an appreciable,
persistent effect on aggregate supply?.... More research is needed, however, to better
understand the influence of movements in aggregate demand on aggregate supply.
Aggregate demand shocks, particularly monetary policy shocks, do indeed have long-lasting effects
on the level of output, capital stock and TFP in the economy.
2. Data and series construction
The empirical features motivating our analysis rest on two major international and historical
databases. Data on macro aggregates and financial variables, including assumptions on exchange
rate regimes and capital controls can be found in www.macrohistory.net/data. This database
covers 17 advanced economies reaching back to 1870 at annual frequency. Detailed descriptions
of the sources of the variables contained therein, their properties, and other ancillary information
are discussed in Jordà, Schularick, and Taylor (2017) and Jordà, Schularick, and Taylor (2019), as
well as references therein. Importantly, we will rely on the trilemma instrument discussed in Jordà,
Schularick, and Taylor (2016), and more recently, Jordà, Schularick, and Taylor (2019) as the source
of exogenous variation in interest rates. We briefly describe the instrument construction below but
refer the reader to the last reference for a detailed analysis.
The second important source of data relies on the work by Bergeaud, Cette, and Lecat (2016) and
available at http://www.longtermproductivity.com. This historical database adds to our main
database observations on capital stock (machines and buildings), hours worked, and number of
employees, and the Solow residuals (raw TFP). In addition, we construct time-varying capital and
labor utilization corrected series using the procedure discussed in Imbs (1999) with the raw data
from Bergeaud, Cette, and Lecat (2016) to construct our own series of utilization-adjusted TFP. We
went back to the original sources so as to filter out cyclical variation in input utilization rates in the
context of a richer production function that allows for factor hoarding. We explain the details of this
correction below.
3 See also Fatas (2000) and Barlevy (2004).
3
2.1. Instrument construction
Jordà, Schularick, and Taylor (2019) developed a quasi-natural experiment utilizing the theory of
trilemma in international finance: a country with fixed nominal exchange rates and open capital
flows loses monetary independence. Variations in the base country interest rates can be used as an
instrumental variable to identify exogenous monetary shocks to an open peg country.
The sample is split into three group of countries, bases whose currency serve as the anchor for the
second group of pegging economies, labeled as the pegs, and floats are the final group of countries
that allow their currency to be freely determined in the market. A country i is defined to be in a
peg qi,t = 1 at date t if it maintained a peg at dates t − 1 and t. This conservative definition serves
to eliminate opportunistic pegging due to country’s monetary conditions.In order to construct the
instrument, changes in short term nominal interest rate in the base country are first sterilized to
remove the component that can be explained by economic conditions in that country. The resulting
variation is adjusted for capital openness.
More formally: let ∆ri,t denote the changes in short term interest rate in country i at date t,
∆rb(i,t),t be the change in short term interest rate in country i’s base country b(i, t) at time t and
∆r̂b(i,t),t denote the predictable component of variations in base rate. Recognizing that countries
are not perfectly open to capital flows, adjustment for capital mobility is constructed using the
continuous version k i,t ∈ [0, 1] of capital openness index of Quinn, Schindler, and Toyoda (2011).
The resulting instrument is zi,t ≡ k i,t (∆rb(i,t),t − ∆r̂b(i,t),t ).4
2.2. Factor utilization correction

The Imbs (1999) correction follows Burnside and Eichenbaum (1996) in endogenizing the capital
utilization rate in a partial equilibrium model. We assume perfectly competitive factor markets and
an aggregate production function which is constant returns to scale in effective capital and labor:5
Yt = At (Kt ut )α ( Lt et )1−α
where Yt is output, Kt is capital stock, and Lt is total hours worked. ut and et denote the respective
factor utilizations. At is the utilization adjusted TFP. We assume perfect competition in the input
φ
and the output markets. Higher capital utilization increases the depreciation of capital δt = δut
where φ > 1. As a result, firms choose capital utilization rate optimally. Labor hoarding is calculated
assuming instantaneous adjustment of effort et against a payment of a higher wage w(et ), while
keeping fixed employment (determined one period in advance). The firm’s optimization problem is
given by:
max At (Kt ut )α ( Lt et )1−α − w(et ) Lt − (rt + δut ))Kt
φ
et ,ut ,Kt
4 SeeJordà, Schularick, and Taylor (2019) for implementation details.

5 We assume that these variables are stationary. In section 5, we construct capital-utilization in a general
equilibrium model along with endogenous growth.
4
Households choose consumption, labor supply and effort to maximize their lifetime utility subject
to their budget constraint (with complete asset markets)
∞
" #
( e t L t )1+ ν
max ∑ βt
ct ,Lt ,et t=0
ln Ct − χ
1+ν
Normalizing the long-run capital-utilization and labor-utilization rates to one, the utilization
rates can be derived from following :
Yt
! r+δ δ Yt
! 1+1 ν
Kt Ct L
ut = Y
; et = Y
K C
Lt
where Y, C, L and K are the steady-state values of output, consumption, labor and capital.
The Solow residual then can be decomposed into utilization-adjusted TFP and utilization
corrections:
Yt
TFPt ≡ = At × uαt e1t −α
Kt L1t −α
α
To construct steady state values of Y, C, L and K, we extract a HP-filter trend from the data series.
We will show later that our empirical results are robust to computing moving averages over a 10
year window, using time-varying values of α constructed from labor-income data, and reasonable
parameters of the aggregate capital depreciation rate. Bergeaud, Cette, and Lecat (2016) constructed
capital stock for machines and buildings separately using the perpetual inventory method with
data on investment in machines and buildings and different depreciation rates. We will show
robustness of our results to choosing different depreciation parameters. We wish to emphasize that
our estimation of productivity assumes misallocation related-wedges are absent. We have not yet
found the data to take into account markups in our productivity estimation. See Basu and Fernald
(2002) and Syverson (2011) for extensive discussions on what determines productivity.
3. Monetary shocks have long lasting effects
3.1. Empirical approach

The basic empirical approach relies on local projections (Jordà, 2005) estimated with instrumental
variables (LPIV). Several applications of these methods are available in the literature, though a more
general discussion of the method can be found in Ramey (2016), Stock and Watson (2018) and Jordà,
Schularick, and Taylor (2019). Based on the latter, we estimate in particular:
yi,t+h − yi,t−1 = αi,h + ∆

cri,t β h + xi,t γh + vi,t+h ; h = 0, 1, . . . , H; i = 1, . . . , N; t = t0 , . . . , T (1)
where yi,t+h is the outcome variable for country i observed h periods from today; αi,h are country
fixed effects, ∆r
c i,t refers to the instrumented change in the short-term government bond (3-months
5
Table 1: Trilemma instrument: first stage evidence
pegs (q = 1) All years PreWW2 PostWW2

zi,t 0.52∗∗∗ 0.35∗∗ 0.56∗∗∗
t-statistic [8.62] [2.05] [8.97]
Obs 672 148 524
Notes: ∗∗∗ p < 0.01, ∗∗ p < 0.05, ∗ p < 0.1. Full sample: 1890 − 2015 excluding WW1: 1914 − 1919 and WW2: 1939 − 1947. Pre-WW2
sample: 1870-1938 (excluding 1914-1919). Post WW2 sample: 1948 − 2015. These regressions include country fixed effects as well as up
to two lags of the first difference in log real GDP, log real consumption, investment to GDP ratio, credit to GDP, short and long-term
government rates, log real house prices, log real stock prices, and CPI inflation. In addition we include world GDP growth to capture
global cycles. See text.
in duration), our stand-in for the policy rate which we instrument with zi,t , the trilemma instrument
borrowed from Jordà, Schularick, and Taylor (2019) as discussed earlier; and xi,t collects all additional
controls including lags of the outcome and interest rates, as well as lagged values of other macro
aggregates. Moreover, we control for global business cycle effects through a global GDP control
variable to parsimoniously soak up time effects. We estimate Equation 1 with instrumental variable
methods and report cluster robust standard errors.
Table 1 reports the first-stage regression of the pegging country’s short term interest rate ∆ri,t
on the instrument zi,t with controls xi,t , country fixed effects and (robust) clustered standard errors.
The t-statistic is well above 3 for full sample and post-WW2 samples illustrating that it is not a weak
instrument. We refer the reader to Jordà, Schularick, and Taylor (2019) for detailed discussion on the
instrument and proceed henceforth assuming the reader is on board regarding instrument relevance
and strength.
3.2. Main results

The main story is illustrated by the response of real GDP to a shock to domestic interest rates
using the trilemma instrument. Before we show the main results, we highlight the value of our
instrumental variable with a comparison of the response of GDP per capita to a shock in the
short-term domestic interest rate calculated using selection-on-observables identification versus
identification with the trilemma instrument. This is shown in Table 2. The table reports coefficient
estimates of the impulse response calculated with each identification approach for the full and
post-WW2 samples. LP-OLS refers to identification via selection, LP-IV to the trilemma instrument
identification. The samples are restricted to pegging economies to match the samples in both cases.6
Table 2 is organized as follows. We provide the coefficient estimates by row and provide a test of
the null hypothesis that LP-OLS and LP-IV estimates are equivalent for the two samples considered:
full and post-WW2. The differences between identification schemes could not be starker. Both are
economically and statistically, but the LP-IV response is considerably larger at all horizons. We
display these results graphically in Figure 1.
6 The plots and inference are robust to using real GDP per capita. See Table A1
6
Table 2: LP-OLS vs. LP-IV. Attenuation bias of real GDP responses to interest rates.
Trilemma instrument. Matched samples
Responses of real GDP at years 0 to 10 (100 × log change from year 0 baseline).
(a) Full Sample OLS-IV (b) Post-WW2 OLS-IV
Year LP-OLS LP-IV p-value LP-OLS LP-IV p-value
(1) (2) (3) (4) (5) (6)
h=0 0.08∗∗ -0.04 0.18 0.05∗∗ 0.07 0.79
(0.03) (0.09) (0.02) (0.07)
h=2 -0.27 -1.63∗∗∗ 0.00 -0.21 -1.42∗∗∗ 0.00

(0.16) (0.39) (0.13) (0.42)
h=4 -0.11 -2.22∗∗∗ 0.00 -0.01 -1.54∗∗ 0.01

(0.26) (0.56) (0.21) (0.63)
h=6 -0.01 -2.55∗∗∗ 0.00 0.11 -2.14∗∗∗ 0.00

(0.29) (0.67) (0.22) (0.58)
h=8 -0.30 -3.47∗∗∗ 0.00 0.18 -2.02∗∗∗ 0.00

(0.29) (0.85) (0.22) (0.59)
h = 10 -0.33 -4.20∗∗∗ 0.00 0.35 -1.68∗∗∗ 0.00

(0.36) (1.15) (0.27) (0.65)
h = 12 -0.58 -6.77∗∗∗ 0.00 0.24 -2.62∗∗∗ 0.00

(0.42) (2.08) (0.33) (0.95)
KP weak IV 68.34 69.18
H0 : LATE = 0 0.00 0.00 0.00 0.00
Observations 607 607 482 482
Notes: ∗∗∗ p < 0.01, ∗∗ p < 0.05, ∗ p < 0.1. Cluster robust standard errors in parentheses.Full sample:
1890 − 2015 excluding WW1: 1914 − 1919 and WW2: 1939 − 1947. Post WW2 sample: 1948 − 2015. Matched
sample indicates LP-OLS sample matches the sample used to obtain LP-IV estimates. KP weak IV refers to
the Kleibergen-Paap test for weak instruments. H0 : subATE = 0 refers to the p-value of the test of the null
hypothesis that the coefficients for h = 0, ..., 10 are jointly zero for a given subpopulation. OLS = IV shows the
p-value for the Hausmann test of the null that OLS estimates equal IV estimates. See text.
Regardless of the sample used, a 1 percentage point increase in domestic short-term interest
rates has sizable and long-lasting effects on GDP. In the full sample, GDP declines by over 6 percent
over 12 years. The effect, while still large, is considerably more muted in the post-WW2 sample.
The drop 12 years after impact is about half, at 2.7 percent. This is a far cry from traditional notions
of long-run neutrality found in the literature.
What is the source of this persistent decline? We decompose GDP into its components, namely,
hours worked (employees times number of hours per employee); capital stock (measured capital
in machines and buildings); and the Solow residual (using a Cobb-Douglas production function)
labeled as total factor productivity (TFP). (Using the Imbs (1999) correction, in a moment we
decompose the Solow residual into factor-utilization plus a residual utilization-adjusted TFP.)
7
Figure 1: Baseline response to 100 bps trilemma shock: Real GDP
(a) Full sample (b) Post-WW2
Real GDP Real GDP

0
0
-4
Percent
Percent
-2
-8
-4
0 4 8 12 0 4 8 12
Year Year
IV OLS
Notes: Response to a 100 bps shock in domestic interest rate instrumented with the trilemma. Responses for
pegging economies. Full sample: 1890–2015 (World Wars excluded). Post-WW2 sample: 1948–2015. See text.
Figure 2 displays the responses of each of these components to the same shock to the domestic
short-term interest rate instrumented with the trilemma, both for the full and the post-WW2 samples.
The figure displays the responses of total hours worked, capital and raw TFP without error bands to
provide a clearer sense of the dynamic paths. A more detailed figure is provided in the appendix
A.1, which includes the error bands.
Several features deserve mention. Figure 2 shows that there are similar declines in capital and
raw TFP whereas total hours worked exhibits a much flatter pattern. Because capital enters the
production function with a smaller weight, it should be clear from the figure that most of the decline
in GDP is explained by TFP variable, and then capital, with total hours worked mostly flat. To be
sure, the response of hours worked conforms well with the textbook response to a monetary shock.
Total hours fall in the short-run, but then recover quickly and remain mostly flat.
Capital accumulation also follows textbook dynamics in the short-run. The response is initially
muted but builds up over time. But unlike the textbook model, capital does not appear to recover
even 12 years after the shock. Similarly, TFP falls gradually rather than suddenly. Over time, the
decline in TFP accelerates, ending at a level 3 (1) percent lower in full (post WW2) sample by year
12 relative to year 0.
We present the responses of the various components of the Solow residual in Figure 3 for both
the full and post-WW2 samples. Utilization rates of labor and capital exhibit cyclical dynamics:
falling in the short-run and then recovering back to zero. In a sense, this pattern is mechanical. It
reflects the restriction imposed on the calculation that utilization rates must return to zero eventually
(Imbs, 1999).
8
Figure 2: Baseline response to 100 bps trilemma shock: Real GDP and components

2
1
0
0
-2
Percent
Percent
-1
-4
-2
-6
-3
-8
0 4 8 12 0 4 8 12
Year Year
GDP TFP K L
Figure 4 presents the evolution of capital to utilization adjusted TFP ratio in response to the
trilemma shock. The hump-shaped response replicates the conventional justification for including
investment adjustment costs in typical DSGE models (Christiano, Eichenbaum, and Evans, 2005).7
One explanation for the long-lasting effects of the monetary shock could be that domestic interest
rates remain elevated for a long period of time as well. In other words, persistence is generated by a
delayed response in interest rates. A simple check of this proposition can be done in two steps.
Figure 5 shows that the short-term real interest rate does indeed take approximately 8 years to
return to zero, while the nominal interest rate returns to zero after 4 years. The response of nominal
interest rate is typical of what has been reported often in the literature (see, e.g., Christiano et al.,
1999; Ramey, 2016). Secondly, we can calculate the responses of the main variables normalized by
the response of interest rates over time to sterilize the dynamics of interest rates themselves. This is
no different than calculating a multiplier (see, e.g., Ramey, 2016; Ramey and Zubairy, 2018).
Thus, in Figure 6 we show the ratio of the cumulative change in GDP to the area under the
real interest rate path in Figure 5. In a given period, the difference in the level of real interest rate
relative to the counterfactual path measures the tightness of monetary policy. We consider these
cumulative gaps as a measure of overall monetary policy tightness (the area under the solid line
in Figure 5). By year 12, the multiplier is -1 in the full sample and -0.8 in the post-WW2 sample,
7 We
later show the robustness of using a more commonly used utilization adjusted TFP series constructed
by Fernald (2014) for the post-WW2 US, which requires more detailed data than is available for the historical
panel of 17 countries. Reassuringly, the results for utilization adjusted TFP using the two methods are
qualitatively similar.
9
Figure 3: Baseline response to 100 bps trilemma shock: TFP and utilization
.5
1
0
0
-.5
Percent
Percent
-1
-1 -1.5
-2
-2
-3
0 4 8 12 0 4 8 12
Year Year
Raw TFP Util adj TFP K utilization L utilization
Figure 4: Baseline response to 100 bps trilemma shock: Capital to utilization adjusted TFP
K / Util adj TFP K / Util adj TFP

2
1
0
0
Percent
Percent
-2
-1
-4
-2
0 4 8 12 0 4 8 12
Year Year
IV OLS
10
Figure 5: Baseline response to 100 bps trilemma shock: Short term real interest rate
Short term real interest rate Short term real interest rate
1.5
2
1.5
1
1
.5
.5
0
-.5
0
0 4 8 12 0 4 8 12
Year Year
Notes: Response to a 100 bps shock in domestic interest rate instrumented with the trilemma. Responses
of short term real interest rate for pegging economies. Inflation expectations constructed from the impulse
response of consumer price level index to the same trilemma shock. Full sample: 1890–2015 (World Wars
excluded). Post-WW2 sample: 1948–2015. See text.
Figure 6: Cumulative change in real GDP / Cumulative short term expected real interest rate gap
Real interest rate multiplier Real interest rate multiplier

0
0
-.2
-.2
-.4
-.4
-.6
-.6
-.8
-.8
-1
-1
0 4 8 12 0 4 8 12
Year Year
Notes: Response to a 100 bps shock in domestic interest rate instrumented with the trilemma. Plots path of
cumulative change in real GDP divided by cumulative change in short term nominal interest rate for pegging
economies. Full sample: 1890–2015 (World Wars excluded). Post-WW2 sample: 1948–2015. See text.
11
virtually identical and sizable.8 These numbers compare with those obtained in the literature using
VAR and Romer and Romer (2004) shocks for the US.9
4. Threats to identification and robustness
4.1. Open economy threats to Identification

We use a variant of the well known Mundell-Fleming-Dornbusch model to illustrate how (static)
identification of monetary policy shocks using the trilemma mechanism can be obtained. The model
incorporates the innovations in Blanchard (2016) and Gourinchas (2018), which embed various
financial spillovers. Intuition is best communicated in a static setting. Later we extend the model to
a dynamic setting with rational expectations.
Suppose there are two countries: a small domestic economy and a large foreign country. Foreign
variables are denoted with an asterisk, and we refer to this large country as the US for simplicity.
Assume prices are perfectly rigid. The following equations describe the setup, for given interest rate
policies in the two countries.
Y = A + NX (2)
A = ξ − cR − f E (3)
NX = a(Y ∗ − Y ) + bE (4)
Y ∗ = A∗ = ξ ∗ − cR∗ (5)
E = d( R∗ − R) + gR∗ + χ (6)
where a, b, c, d, f , g, χ ≥ 0. Domestic output is equal to the sum of domestic absorption A and next
exports NX. Domestic absorption depends on an aggregate demand shifter ξ, and negatively on
the domestic policy rate R. f denotes financial spillovers through the exchange rate (e.g. balance
sheet exposure of domestic producers in a dollarized world).10 If f ≥ 0, then a depreciation of
the exchange rate E hurts absorption. Net exports depends positively on US output Y ∗ , negatively
on domestic output Y, and positively on the exchange rate. US output is determined in similar
fashion except that the US is considered a large country, so it is treated as a closed economy. Finally,
the exchange rate depends on the difference between domestic and US interest rates and on a
risk-premium shock. The term g is intended to capture risk-premium effects associated with US
monetary policy.
8 For real GDP per capita, the multiplier is -1.4 in the full sample and -1.3 in the post-WW2 sample by
year 12.
9 In their online appendix (Table A.1), Nakamura and Steinsson (2018) report the multiplier of monthly
industrial production to monetary shocks over 36 months to lie between 1 and 2 using the local projections
specification for VAR shocks and Romer-Romer shocks.
10 Jiang, Krishnamurthy, and Lustig (2018) provide a micro-foundation to generate these spillovers associ-
ated with the global financial cycle (Rey, 2015).
12
Let ∆R∗ be the instrument zi,t ≡ k i,t (∆rb(i,t),t − ∆r̂b(i,t),t ) described earlier. By construction, the
change in US interest rates is unpredictable by US macro economic-conditions. We next show the
threats to identification of domestic monetary shocks that arise in this open economy model.
4.1.1 Textbook specification with hard pegs
Under the assumption that f = g = χ = 0, the model reduces to the textbook Mundell-Fleming-
Dornbusch version. In this model, the change in output can be decomposed into two conventional
sources:
∆Y = − c∆R + ∆NX
| {z }
object of interest
A change in interest rates in the US will affect the home economy through two channels:
domestic absorption and net exports. An endogenous increase in domestic interest rates reduces
absorption and hence output. This generates an improvement in net exports through a contraction
in demand for imports. A contraction in the US economy from an increase in interest rates reduces
demand for domestic exports. Endogenous movements in the exchange rate also affect net exports.
When the domestic economy follows a hard peg policy, the domestic monetary authority follows an
interest rate policy that guarantees the fixed exchange rate. Consequently, a change in US policy
rate ∆R∗ , changes the home policy rate by one to one, i.e. ∆R = ∆R∗ .
Proposition 1. Let g = f = χ = 0. If the domestic policy maker fixes the exchange rate (∆E = 0), then a
change in the US policy rate ∆R∗ , changes the home policy rate one to one, i.e. ∆R = ∆R∗ , and negatively
affects domestic output:
1
∆Y = [−c∆R + a∆Y ∗ ]
1+a
Since this endogenous change in home rates is exogenous to home country conditions, it can
be used to identify the effects of a closed-economy monetary policy shock. As evident in the
proposition, the total effect on home output will be dampened by 1 + a because of the endogenous
contraction in imports from abroad,. If the US interest rate shock is purely exogenous, the demand
for home output in the US contracts, worsening the output drop at home. These two forces pose a
threat to identification of a domestic monetary policy shock.
4.1.2 Financial spillovers with dirty float policy
Having shown the threat to identifications in the simple model, we now allow for financial spillovers
i..e g > 0 and f > 0. We also depart from a hard peg policy to allow for dirty floats policy,
which we define as follows: the domestic economy follows a dirty float policy if the endogenous
(to US interest rate movements) change in home interest rate is less than under a hard peg, i.e.
abs(∆R) < abs(∆R∆E=0 ). We surmise a general Taylor rule where the domestic economy puts
non-zero weight on output stability, along with exchange rate stability in setting domestic interest
rates.
13
d+ g
Proposition 2. If the domestic policy maker manages a dirty float (i..e |∆R| ≤ d |∆R∗ |, then the effect on
domestic output is given by::
(1 + a)∆Y = −c∆R + a∆Y ∗ + (b − f )∆E
Two additional sources of spillovers open up in this extended environment. A global financial
cycle spillover g > 0 amplifies the effects on home interest rates. Under a hard peg policy, an
d+ g
increase in US interest rates increases home interest rates by > 1. Partial flexibility in exchange
d
rates under a dirty float reduces the pass-through to home interest rates. This flexibility in exchange
rates activates financial and trade spillovers due to dependence of A and NX on E.
Controls for net exports and exchange rate identify the effects of a closed economy monetary
shock. Next we discuss the corrections for spillovers motivated by our reduced form model.
4.1.3 Controlling for base country GDP growth, current account and exchange rate
A monetary tightening in the base country may reduce the demand for goods from the pegging
economy. This effect would amplify the effect of the trilemma shock on home output. Another
implication from the Mundell-Fleming-Dornbusch model is that there are financial spillovers that
may amplify the effects through the exchange rate channel. To orthogonalize these effects, we
control for base country’s GDP growth rate, exchange rate of the pegging economy with respect to
the USD and the current account of the peg. Since we do not have exchange rate data with respect
to other countries, we indirectly control for those spillovers using the current account of the peg
country at each horizon. We estimate the following specification:

yi,t+h − yi,t−1 = αi,h + ∆r
c i,t β h + xi,t γh + Bb(i,t),t+h , CAi,t+h , XRUSDi.t+h γ̂h + νi,t+h , for h = 0, ..., H − 1
where Bb(i,t),t+h is GDP growth of base country b(i, t) at time t + h where i is the pegging country,
CAi,t+h is the current account and XRUSDi,t+h is the exchange rate with respect to USD of country
i at time t + h.
Figure 7 plots the IRFs to trilemma identified shock. The identified monetary policy shocks have
quantitatively and statistically significant effects on domestic output twelve years later. Controlling
for variables motivated by Proposition 2 does not affect our estimates until year 4. Thereafter, the
effects are somewhat attenuated but statistically significant.
4.2. Spillover correction for the trilemma instrument

A violation of the exclusion restriction could occur if base rates affect home outcomes through chan-
nels other than movements in home rates or the spillovers highlighted inProposition 2. Additional
influences via such channels are sometimes referred to as spillover effects. These could occur if base
rates proxy for factors common to all countries. That said, these factors would have to persist despite
14
Figure 7: Response to 100 bps trilemma shock with controls motivated by Proposition 2: Real GDP
(a) Full sample (with Base Cycle, USD XR, Current Account) (b) Full sample (Baseline)
Real GDP Real GDP
0
0
-4
-2
Percent
Percent
-8
-4
0 4 8 12 0 4 8 12
Year Year
IV OLS
pegging economies. Full sample: 1890–2015 (World Wars excluded). Post-WW2 sample: 1948–2015. LP-OLS
estimates displayed as a dashed red line, LP-IV estimates displayed as a solid blue line and 1 S.D. and 90%
confidence bands. See text.
having included global GDP to soak up such business cycle variation. We now assess such spillover
effects more formally, using two separate approaches: a) a control function approach developed
in Jordà, Schularick, and Taylor (2019), and b) controlling for foreign variables at each horizon to
orthogonalize any spillover channels from the interest rate channel.
4.2.1 Synthetic control function approach
First test for exclusion restriction violation follows the control function approach developed in Jordà,
Schularick, and Taylor (2019). It exploits the presence of subpopulation of floats in our sample
which for example contain information about the global factors at the time of the trilemma shock.
Figure 8 shows our spillover-adjusted estimates of response of output to a 100 bps monetary policy
shock.
4.2.2 Orthogonalized interest rate channel
A second approach that attempts to provide validity to the exclusion restriction is directly con-
trolling for a primary channel through which the spillover effects may originate. This reduction
in demand my arise from other trading partners when the tightening affects other countries as
well. Or the interest rate channel induced contraction in pegging economy by reducing demand
for other countries’ output may be subject to spillbacks. If the transmission is primarily driven by
15
Figure 8: Response to 100 bps trilemma shock with spillover corrections: Real GDP
Real GDP Real GDP

0
0
-4
Percent
Percent
-2
-8
-4
0 4 8 12 0 4 8 12
Year Year
IV OLS IV spillover corrected
confidence bands, LP-IV spillover corrected estimates displayed as a light green shaded area with dashed
border, using λ ∈ [1, 18]. See text and Jordà, Schularick, and Taylor (2019).
increased trade, controlling for global GDP growth can potentially absorb these effects allowing us
to orthogonalize domestic demand effects with respect to international spillbacks. We augment the
baseline specification as follows:
yi,t+h − yi,t−1 = αi,h + ∆r

c i,t β h + xi,t γh + Gt+h γ̂h + νi,t+h , for h = 0, ..., H − 1
where Gt+h is global GDP growth at time t + h.

Figure 9 produces the results from the estimation with global GDP growth at each horizon. In
comparison to the baseline specification, we still find very persistent and significant effects on GDP.
4.3. Accounting for structural breaks

Fernald (2014) and Gordon (2016) have convincingly argued that there are structural breaks in
TFP growth in the US economic trajectory. It is plausible that there are structural breaks in other
economies’ TFP growth rates. If these structural breaks implying slowdown in TFP growth occur
around the identified monetary shocks, it could bias our results leading us to attribute the persistent
effects incorrectly to monetary shocks. To address this concern, we first estimate five structural
breaks in TFP growth for each country in our sample using the UD-max statistic of Bai & Perron
(1998). We report these estimated structural break dates in the appendix A.2. Then in our baseline
16
Figure 9: Response to 100 bps trilemma shock with foreign variables controlled: Real GDP
(a) Full sample (with Global Cycle) (b) Full sample (Baseline)
Real GDP Real GDP
0
0
-2
-2
-4
Percent
Percent
-4
-6
-6
-8
-8
0 4 8 12 0 4 8 12
Year Year
IV OLS
confidence bands. See text.
specification, we allow output growth to lie in either of the five regimes at horizon zero as well as
horizon h: i.e.
yi,t+h − yi,t−1 = αi,h + ∑ ( Di,k,t + Di,k,t+h ) + ∆r

c i,t β h + xi,t γh + νi,t+h ,
k −1
where Di,k,t+h is country-specific dummy for TFP growth regime k (Bai-Perron) at horizon h =
0, ..., H − 1 and k ∈ (1, 5). Notice that this specification is conservative whereby we allow horizon h
regime changes in the estimation along with horizon 0 regimes.
Figure 10 compares the estimated impulse response when including structural breaks in the left
panel and the baseline specification of no structural breaks in the right panel. Taking structural
breaks in account does not change the result that there are persistent effects on output of monetary
shocks.11
4.4. Levels, differences, and number of lags

We report the robustness of IRFs estimated in the baseline to adding the control variables xi,t in
levels instead of first differences in the left panel of Figure 11, as well as to including up to 5 lags of
the control variables in the right panel.
11 In
the appendix A.2, we report the IRFs when controlling for country specific structural breaks in growth
rate of real GDP per capita.
17
Figure 10: Response to 100 bps trilemma shock with structural breaks: Real GDP
5 breaks in TFP and expected TFP no breaks in TFP
Real GDP Real GDP
0
0
-2
-2
-4
Percent
Percent
-4
-6
-6
-8
-10
-8
0 4 8 12 0 4 8 12
Year Year
IV OLS IV OLS
Notes: Response to a 100 bps shock in domestic interest rate instrumented with the trilemma.
Responses for pegging economies. Full sample: 1890–2015 (World Wars excluded). Post-WW2
sample: 1948–2015. LP-OLS estimates displayed as a dashed red line, LP-IV estimates displayed as
a solid blue line and 1 S.D. and 90% confidence bands. See text and Jordà, Schularick, and Taylor
(2019).
Figure 11: Response to 100 bps trilemma shock with controls in levels: Real GDP
Real GDP: controls in levels Real GDP: controls in differences

0
0
-2
-2
-4
Percent
Percent
-4
-6
-6
-8
-10
-8
0 4 8 12 0 4 8 12
Year Year
IV OLS IV OLS
Responses for pegging economies. Full sample: 1890–2015 (World Wars excluded). LP-OLS
estimates displayed as a dashed red line, LP-IV estimates displayed as a solid blue line and 1 S.D.
and 90% confidence bands. See text and Jordà, Schularick, and Taylor (2019).
18
Figure 12: Estimated IRFs using LP(p) and AR(p)
Monte Carlo Simulation: AR(2) and AR(4) vs LP (2)

1000 Monte Carlo replications. Sample size: 150 obs
0
-1
Response
-3
-4-2
True response AR(2) response
AR(4) response LP(2) response
0 5 10
Horizon
Notes: Solid black line denotes the basline response of real GDP in pegging economies to a 100 bps
shock in domestic interest rate instrumented with the trilemma. Sample: 1890–2015 (World Wars
excluded).
4.5. Why might VARs not find persistent effects?

That a misspecified VAR suffers from compounding of model mis-specification errors gives local
projections approach is a well-known advantage. We provide an example here that suggests why
researchers may not be able to estimate the long-run effects that we find when estimating VARs in
finite samples with few lags. Using the estimated IRFs in the baseline model for the full sample
over 12 years, we recover the coefficients of an invertible MA(12) process and generate data using
this data generating process. Figure 12 compares the IRFs obtained from estimating AR(2), AR(4),
and a local projection with 2 lags. AR(4) outperforms AR(2) in replicating the true impulse response
at horizons greater than two. The misspecification errors get compounded at higher horizons under
AR(2) versus AR(4), while local projection is not prone to this problem.
4.6. Is the US different?

The US for most of our historical sample is not a pegging economy (apart from the Gold standard
years). It is the quintessential base country for many economies in our sample. For this reason, the
trilemma instrument mechanically sets aside any information coming from the US during estimation.
It is natural to wonder the extent to which US data conforms with the patterns presented so far.
In this section, we examine US data post-WW2. This allows us to incorporate three useful
modifications. First, we use higher frequency quarterly data. Second, we use the alternative
utilization adjusted series for TFP constructed by Fernald (2014). Third, in order to achieve
identification we rely on the instrumental variable constructed by Romer and Romer (2004) based
on the Federal Reserve staff’s implied forecast errors for the policy rate, and extended to recent
years by Wieland and Yang (2016).
19
Figure 13: Baseline response to 100 bps Romer and Romer (2004) shock : US postwar data
Real GDP (Util. Adj.) TFP index (Fernald 2014)
.5
.5
0
0
-.5
Percent
Percent
-.5
-1
-1.5
-1
-2
0 8 16 24 32 0 8 16 24 32
Quarter Quarter
IV OLS
Hours, bus sector Capital input

1
0
-.5
0
Percent
Percent
-1
-1
-1.5
-2
-2
0 8 16 24 32 0 8 16 24 32
Quarter Quarter
IV OLS
Notes: Response to a 100 bps shock in federal funds rate rate instrumented with policy forecast residuals
(Romer and Romer, 2004; Wieland and Yang, 2016). Responses of real GDP, utilization-adjusted TFP (Fernald,
2014), capital stock and hours worked for US economy. Quarterly sample: 1969-Q1: 2007-Q4. Quarterly data
series are taken from Fernald (2014).
It turns out that results based on U.S. data largely confirm the results we reported in the previous
section for non-U.S. pegging economies. Figure 13 plots the the path of real GDP along with its
three components: total hours worked, capital, and utilization adjusted TFP. The responses are
qualitatively similar to those in the long-run panel, although the amplitudes are more muted.
Quarterly data is naturally noisier than yearly data, but smoothing over a temporary recovery in
GDP 4 to 5 years after the shock, real GDP ends nearly one percent lower 8 years after impact.
20
Figure 14: Baseline response to 100 bps Romer and Romer (2004) shock: US postwar data
Instrument: Romer & Romer (2004) residuals
.5
0
Percent
-.5
-1
0 4 8 12 16 20 24 28 32
Quarter
GDP Util adj TFP K L LQ
Notes: Response to a 100 bps shock in overnight federal funds rate rate instrumented with policy forecast
residuals (Romer and Romer, 2004; Wieland and Yang, 2016). Responses of real GDP, capital stock, total hours
worked, labor composition/quality, and raw TFP for US. Quarterly sample: 1969-Q1: 2007-Q4. Quarterly data
series are taken from Fernald (2014). See text.
Utilization adjusted TFP and hours exhibit a similar u-shaped pattern, with TFP nearly back to
zero by year 8. Strikingly, capital accumulation exhibits a protracted decline over the entire period,
ending about 1.25 percent lower after eight years. For comparison, we plot the various components
on the same graph in Figure 14.12
The data for utilization-adjusted TFP series are based on sectoral data for the US that account for
heterogeneity across workers and types of capital. Fernald (2014) notes that there are various other
corrections that are not conducted in the quarterly series due to the lack of rich-industry level data.
The finding that monetary policy shocks can affect utilization-adjusted TFP echo the Evans
(1992)’s critique of using Solow residuals as productivity shocks in RBC models. While the
construction of quarterly utilization-adjusted TFP series is detailed and thorough, our analysis
suggests caution against using the quarterly-adjusted residuals as “pure” TFP shocks (i.e. perfectly
12 We estimate the following specification for the US economy:
y t + h − y t −1 = α h + ∆
cr t β h + xt γh + vt+h ; h = 0, 1, . . . , H; i = 1, . . . , N; t = t0 , . . . , T
where yt+h is the outcome variable at horizon h, ∆cr t is the instrumented change in the Federal Funds rate,
xt is the set of controls that includes contemporary and four lags of log real GDP, log CPI, and changes in
federal funds rate. We do not include the contemporary variable when it is same as the dependent variable.
We report robust standard errors.
21
orthogonal to demand shocks).13,14
5. A model of hysteresis
Impulse responses calculated with standard methods that internally favor reversion to the mean will
tend to underestimate the value of the response at longer horizons. By relying on local projections,
we allow the data to more directly speak as to its long-run properties. The evidence presented in
the previous sections strongly indicate that these long-run effects are important and require further
investigation. In order to think through a possible mechanism that explains our empirical findings,
we augment a textbook New Keynesian model with endogenous growth in a stylized manner. We
present the different components of the model in the next few sections, starting with the production
side of the economy.
5.1. Monopolistically competitive producers

Assume there is a continuum of differentiated intermediated good producers that sell the inter-
mediate good Ykt . These goods can be aggregated into a Dixit-Stiglitz final composite good Yt as
follows: 1+ λ p
1 1
Z
1+ λ p
Yt = Ykt dk
0
where λ p > 0 is the price markup. The iso-elastic demand for intermediate good k is given by:
− 1+λ λ p
Pkt p
Ykt = Yt
Pt
The zero profit condition for competitive final good producers implies that the aggregate price index
is −λ p
1 − λ1p
Z
Pt = Pkt dk
0
Each intermediate good k is produced by a price-setting monopolist using labor Lkt and physical
capital Kkt 15 :
Ykt = ( Zt Lkt )1−α Kkt
α
13 Ramey(2016) also documents that utilization adjusted TFP series fail Granger causality tests (See Table
11 in her paper). We are grateful to Valerie Ramey for alerting us to that analysis.
14 In the appendix B, we show that similar results are obtained with samples beginning until at least
1973Q2. However, these persistent effect results are not robust to considering even shorter samples for the US
economy. This is consistent with the findings of Coibion, Gorodnichenko, and Ulate (2017).
15 We can append fixed cost in the production function to eliminate steady state profits. This is usually
done to justify no entry and exit in the steady state in a DSGE model (Christiano et al. 2005, Justiniano,
Primiceri, and Tambalotti 2013, Smets and Wouters 2007). In a micro-founded model of growth, positive rents
are needed to incentivize investment in growth (Romer, 1990).
22
where Zt is the aggregate TFP. The variable Zt denotes a non-stationary TFP series that we describe
in the next subsection.16 Firms may not be able to adjust their price in a given period, but they will
always choose inputs to minimize total cost each period. The cost minimization yields the input
demand functions.
Kkt α

Wt = (1 − α) mckt Ft1−α
Lkt
α −1
Kkt
Rkt =α mckt Ft1−α
Lkt
The first order condition implies that the capital labor ratio at the firm level is independent on
firm-specific variables:
Kkt Kt α Wt
= =
Lkt Lt 1 − α Rkt
Thus, (nominal) marginal cost is independent of firm specific variables:
α 1− α
Rkt

1 Wt
Pt mckt = Pt mct =
Ft1−α α 1−α
Each firm k is assumed to set prices on a staggered basis following Calvo (1983). With probability
(1 − θ p ), a firm adjusts its price independent of previous history. A resetting firm chooses P̃kt to
maximize:
∞
P̃kt
Et ∑ θ p Qt,s
s−t
− mcs Ys (k)
s=t Ps
subject to demand for its product

− 1+λ λ p
Pkt p
Ykt = Yt
Pt
where the stochastic discount factor in period s relative to period t is given by:
Λs Pt
Qt,s = βs−t
Λt Ps
and Λt is the marginal utility of consumption defined later. The first order condition is :
∞ − 1+λ λp p
P̃t P̃t
Et ∑ θ sp−t Qt,s − (1 + λ p ) mcs Ys = 0
s=t Πt,s Πt,s
By the law of large numbers, the law of motion of the aggregate price index Pt is given by:
1 1 1
λp
= (1 − θ p )( P̃t ) λ p + θ p Pt−p1
λ
Pt
16 Relative
to the conventional literature, we will allow for an endogenous relationship between TFP growth
and output gap.
23
5.2. Hysteresis effects
In order to be able to capture the empirical features describe in the previous sections, we examine
a richer specification of the low of motion for total factor productivity than is conventional. In
particular, we assume that the law of motion for Zt is:

f ,t−1
log Zt = log Zt−1 + µt + η log Yt−1 /Yt−1
where µt is the exogenous component of the TFP growth rate, that may be subject to trend shocks.
f ,t−1
Yt−1 is the flexible price level of output in period t − 1 conditional on Zt−1 , and will be referred to
as the potential output at time t − 1. The second component denotes the endogenous component of
TFP growth, where η is the elasticity of TFP growth rate with respect to fluctuations in output due
to nominal rigidities. We refer to this as the hysteresis elasticity (to be consistent with DeLong and
Summers 2012).
The above law of motion allows business cycles to affect TFP growth rate only in the presence of
nominal rigidities or inadequate stabilization. For clarity, we employed this reduced form equation.17
A micro-founded model of innovation and productivity growth that yields this exact representation
under monetary policy shocks can be found in the recent literature embedding endogenous growth
into DSGE models (Bianchi et al., 2019; Garga and Singh, 2016). The effects of business cycles on
TFP growth rate that are unrelated to nominal rigidities can be denoted by time varying values of µt ,
which may depend on other shocks (markup shocks, stationary TFP shocks, discount factor shocks,
capital quality shocks etc.). For ease of exposition, we only focus on the hysteresis effects induced
by the presence of nominal rigidities and treat µt to be an exogenous series. Movements in this
series can be used to induce state-dependent hysteresis effects of monetary policy shocks.
This functional dependence creates a role for hysteresis stabilization by central banks in a
reduced form manner (Yellen, 2016). 18 Long-run effects of monetary policy shocks depend on the
value of η. To clarify, in this paper, we are only able to discuss the sign and the magnitude of η in
response to temporary monetary shocks denoted as η mp . We assume that η mp > 0 and the exact
quantitative magnitudes can extracted from the empirical IRFs estimated above.
5.3. Households
Rest of the model components are standard. We briefly summarize them here and leave the detailed
derivations to the appendix.
17 Asimilar setup was used by Stadler (1990) in his seminal work.
18 Theoretically,
there is no apriori reason to expect η to be positive. While a ‘cleansing’ effect of recessions
may induce counter-cyclicality, recessions may reduce funding access to firms to conduct R&D, skill develop-
ment, and learning-by-doing. The sign on the cyclicality of TFP misallocation is also ambiguous and depends
on the assumptions in a model.
24
5.3.1 Households
Each household supplies differentiated labor indexed by j. Household j chooses consumption Ct ,

risk-free nominal bonds Bt , investment It and capital utilization ut to maximize the utility function,
with external habits over consumption:

ω 1+ ν
Et Σ ∞
s=t β s−t
log(Cj,s − hCj,s−1 ) − L
1 + ν j,s
where h is the degree of habit formation, ν > 0 is the inverse Frisch elasticity of labor supply,
ω > 0 is a parameter that pins down the steady-state level of hours, and the discount factor β
satisfies 0 < β < 1. We assume perfect consumption risk sharing across the households. As a result,
household’s budget constraint in period t is given by
Pt Ct + Pt It + Bt+1 = Bt (1 + it ) + BSj,t + (1 + τ w )Wt L j,t + Γt + Tt + RtK ut Ktu − Pt a(ut )Ktu (7)
where It is investment, BSj,t is the net cash-flow from household j’s portfolio of state-contingent
securities. Labor income Wt L j,t is subsidized at a fixed rate τw . Households own an equal share of
all firms, and thus receive Γt dividends from profits. Finally, each household receives a lump-sum
government transfer Tt . Since households own the capital and choose the utilization rate, the amount
of effective capital that the households rent to the firms at nominal rate RtK is :
Kt = ut Ktu
The (nominal) cost of capital utilization is Pt a(ut ) per unit of physical capital. As in the literature
(Smets and Wouters 2007) we assume a(1) = 0 in the steady state and a00 > 0. Following Christiano,
Eichenbaum, and Evans (2005), we assume investment adjustment costs in the production of capital.
Law of motion for capital is as follows:

It
Ktu+1 = 1−S It + (1 − δk )Ktu
(1 + gss ) It−1
where gss ≡ µ̄ is the steady state growth rate of Zt . Utility maximization delivers the first order
condition linking the inter-temporal consumption smoothing to the marginal utility of holding the
risk-free bond
Λ t +1

Pt
1 = βEt (1 + i t ) (8)
Λt Pt+1
The stochastic discount factor in period t + 1 is given by:
Λt+1 Pt
Qt,t+1 = β
Λt Pt+1
25
where Λt is the marginal utility of consumption given by:
1 hβ
Λt = −
Ct − hCt−1 Ct+1 − hCt
The household does not choose hours directly. Rather each type of worker is represented by a
wage union who sets wages on a staggered basis. Consequently the household supplies labor at the
posted wages as demanded by firms.
We introduce capital accumulation through households. Solving household problem for invest-
ment and capital yields the Euler condition for capital:
" !#
Λ t +1 RtK+1
qt = βEt ut+1 − a(ut+1 ) + qt+1 (1 − δk )
Λt Pt+1
where the (relative) price of installed capital qt is given by

It 0 It It
qt 1 − S −S
(1 + gss ) It−1 (1 + gss ) It−1 (1 + gss ) It−1
2
Λ

1 It+1 It+1
+ β t +1 q t +1 S0 =1
Λt (1 + gss ) It (1 + gss ) It
Choice of capital utilization rate yields:
RtK
= a0 (ut )
Pt
5.3.2 Wage setting
Wage Setting follows Erceg, Henderson, and Levin (2000) and is relatively standard. Perfectly
competitive labor agencies combine j type labor services into a homogeneous labor composite Lt
according to a Dixit-Stiglitz aggregation:
Z 1 1
1+ λ w
1+ λ w
Lt = L j,t dj
0
where λw > 0 is the nominal wage markup. Labor unions representing workers of type j set wages
on a staggered basis following Calvo (1983), taking given the demand for their specific labor input:
− 1+λ λw −λw
Wj,t 1
Z −1
w
λw
L j,t = Lt , where Wt = Wj,t dj
Wt 0
In particular, with probability 1 − θ, the type-j union is allowed to re-optimize its wage contract
and it chooses W̃ to minimize the disutility of working for laborer of type j, taking into account
26
the probability that it will not get to reset wage in the future.19 The first order condition for this
problem is given by:
∞
" #
Lνj,t+s
Et ∑ ( βθw ) s
Λt+s (1 + τtW )W̃t − (1 + λw )ω
Λt+s
L j,t+s = 0 (9)
s =0
By the law of large numbers, the probability of changing the wage corresponds to the fraction of
types who actually change their wage. Consequently, the nominal wage evolves according to:
1 1 1
Wtλw = (1 − θw )W̃tλw + θw Wtλ−w1
where the nominal wage inflation and price inflation are related to each other :
Wt wt 1 1
πtw = =
Wt−1 w t −1 π t 1 + g t
Pt Wt
where πt ≡ Pt−1 is the inflation rate, wt ≡ Pt Zt is the productivity adjusted real wage and gt is the
growth rate of Zt .
5.4. Government
The central bank follows a Taylor rule in setting the nominal interest rate. It responds to deviations
in inflation, output and output growth rate from time-t natural allocations.


ρR φπ !φy 1−ρR !φdy
1 + it 1 + i t −1  πt Yt Yt /Yt−1 mp
= f ,t

f ,t f ,t−1
et (10)
1 + iss 1 + iss πss Yt Yt /Yt−1
f ,t
where iss is the steady state nominal interest rate, Yt is the time-t natural output, ρ R determines
mp
interest-rate smoothing and ∼ N (0, σr ) is the monetary policy shock.
et
We assume government balances budget every period:
Z 1
p
Pt Tt = τ pit xit di + τ w Wt Lt + Pt Gt
0
where Gt is the government spending, which is determined exogenously as as a fraction of GDP

!
1
Gt = 1− g Yt
λt
19 We assume imperfect wage indexation in our nominal wage rigidity assumption. We ignore specifying it
here for ease of exposition. See appendix for details.
27
where the government spending shock follows the process:
g g g g
log λt = (1 − ρ g )λ g + ρ g log λt−1 + et ; et ∼ N (0, σg )
5.5. Market clearing

Market clearing requires
Yt = Ct + It + a(ut )Ktu + Gt
5.6. Simulations
As the DSGE model is intentionally standard, we take parameters from the literature Justiniano
et al. (2013). We report these in Table 4. The steady state parameters imply (annualized) real interest
rate of 2.40%, and an investment-GDP ratio of 17%. For the monetary shock process, we chose the
following parameters σr = 0.02 and ρ R = 0.8.20 The short term nominal interest rate increases by
about 10 basis points on impact in the three simulations that we report here.
The new parameter in our model, relative to the business cycles literature, is η: the hysteresis
elasticity. Table 3 reports the point estimates for η implies by the estimated impulse responses. We
take an average of the IRF of raw TFP and the IRF of GDP to the respective monetary policy shock
in computing this elasticity. Following the persistent drop in output after the Great Recession in
the US, DeLong and Summers (2012) infer that this parameter could be as high as 0.24. In our
calibration henceforth, we use the value of 0.18.
Figure 15 plots the model-implied impulse responses for output, capital stock, real interest rate
and capital to utilization adjusted TFP after a monetary policy shock. Solid line reports the IRFs
for endogenous growth model with η = 0.18, and dashed line reports IRFs for the comparable
exogenous growth benchmark i.e. η = 0. The IRFs for output and capital stock are plotted in percent
deviations from an exogenous trend. For real interest rate, we plot the actual path of real interest
rate. Capital to utilization adjusted TFP ratio is in percent deviation from steady state ratio. Time is
in quarters.
The model replicates the estimated empirical patterns. There is a persistent decline in cap-
ital stock, output and TFP. Furthermore, the endogenous growth model exhibits considerable
amplification to the transitory shock because of the large hysteresis elasticity.
We define the accumulated gaps in TFP growth rate as the hysteresis. We next show the path of
output, and capital when the central bank sets interest rates following an augmented Taylor rule:


ρR φπ !φy ! φ H  1− ρ R !φdy
1 + it 1 + i t −1  πt Yt Ht Yt /Yt−1 mp
= f ,t f ,t

f ,t f ,t−1
et
1 + iss 1 + iss πss Yt Ht Yt /Yt−1
20 Note that this exercise is merely illustrative. A detailed investigation is pending until the next iteration
of the draft.
28
Table 3: Point estimates for hysteresis elasticity η
pegs (trilemma)
Data 1890-2015 1948-2015
η 0.18 0.42
Notes: The point estimates are calculated by taking an average of the IRF of raw TFP and the IRF of GDP to the monetary policy shock.
Figure 2 report the IRFs for GDP and TFP.
Table 4: Parameters
Steady State Parameters

β δk α µ
Discount Capital Capital Trend
factor depreciation share growth rate
rate
0.999 0.025 0.28 2%
Parameters Characterizing the Dynamics

ν λp λw θp θw h
Inverse Price s.s. Wage s.s. Price Calvo Wage Calvo (Internal)
Frisch markup markup probability probability habit
elasticity
1.00 0.15 0.15 0.750 0.750 0.5
a00 (1) 1
a 0 (1)
S”(1) φπ φy 1− λg η
Capital Investment Taylor rule Taylor rule Government
utilization adjustment inflation (normalized) output spending Hysteresis
cost cost response response share elasticity
4 2 1.50 0.125 0.20 0.05
Notes: The table shows the parameter values of the model for the baseline calibration. See text.
where Ht is hysteresis and follows the law motion given by:
f
Ht = Ht−1 + gt − gt
We set φH = 0.2 to plot the graphs. Figure 16 contrasts the path of output and capital stock after
a similar 10 bps shock to the federal funds rate. The real interest rate increases by less than in the
case of the standard Taylor rule (Equation 10). This is because, under a hysteresis targeting rule,
the central bank accommodates above-target inflation at a later time in order to target zero output
hysteresis. Expectations of a high inflation rate induce less contraction in the economy as well as a
sharp recovery of GDP to the pre-shock trend.
29
Figure 15: Response of Output, Capital Stock, Real interest rate and Capital to TFP ratio to a 10 bps increase
in nominal interest rate
Output Capital stock

0.02 0
0
-0.02
-0.02
Exog Growth
-0.04 Endo Growth
-0.04
-0.06
-0.08 -0.06
0 4 8 12 16 20 24 28 32 0 4 8 12 16 20 24 28 32
Real interest rate Capital / Util adj TFP

2.6 0.03
2.55 0.02
2.5 0.01
2.45 0
2.4 -0.01
2.35 -0.02
0 4 8 12 16 20 24 28 32 0 4 8 12 16 20 24 28 32
Notes: The figure plots the model-implied IRFs for output, capital stock, real interest rate and capital to utilization adjusted TFP to
a transitory shock to the assumed Taylor rule. Solid line reports the IRFs for endogenous growth model with η = 0.18, and dashed
line reports IRFs for the comparable exogenous growth benchmark i.e. η = 0. Time is in quarters. IRFs are traced following a one-
time exogenous shock in the federal funds rate of about 10 basis points. The IRFs for output and capital stock are plotted in percent
deviations from an exogenous trend. For real interest rate, we plot the actual path of real interest rate. Capital to utilization adjusted
TFP ratio is in percent deviation from steady state ratio.
6. Conclusion
In this paper, we set out to investigate the widely accepted proposition of long-run money non-
neutrality. Using panel-data spanning over a century and trilemma-identified monetary policy
shocks, we find that monetary policy shocks indeed have long-run effects on output, capital and TFP.
Furthermore, in the quarterly data for the US since 1969, we find that capital stock is permanently
lower after a temporary monetary policy shock identified using a separate instrument. At the same
time, capital to TFP ratio exhibits a hump-shaped relation as commonly found in the empirical
macro-economics literature using vector-autoregression estimation. We reconcile these findings
using a simple extension of the Smets and Wouters (2007) medium-scale DSGE model, where TFP
growth depends on deviations of output from its flexible-price counterpart. Using the model, we
show that a central bank that also targets hysteresis in its policy rule can offset the long-run effects
of monetary policy.
30
Figure 16: Responses of output, capital, real interest rate and inflation rate to 10 bps increase in nominal
interest rate under a Taylor rule and a Hysteresis targeting rule with η = 0.18
Output Capital stock

0.02 0
0
-0.02
-0.02
-0.04
-0.04
-0.06
Taylor Rule
Hysteresis Target
-0.08 -0.06
0 4 8 12 16 20 24 28 32 0 4 8 12 16 20 24 28 32
Real interest rate Inflation rate

2.6 0.05
2.55
0
2.5
2.45
-0.05
2.4
2.35 -0.1
0 4 8 12 16 20 24 28 32 0 4 8 12 16 20 24 28 32
Notes: The figure plots the model-implied IRFs for output, capital, real interest rate and net inflation rate. Time is in quarters. IRFs are
traced following a one-time exogenous shock in the federal funds rate of 10 bps (annualized). The IRFs for output and capital stock are
plotted in deviations from an exogenous trend. See text for details.
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A. Appendix: Additional Graphs Related to Trilemma Shock
A.1. Figure 2 IRFs with error bands
Figure A1: Full Sample: Real GDP and components
IRFs to a 100 bps trilemma shocks: 1890- 2015
real GDP total hours
2
0-4
Percent
Percent
1
-8
0
-12
-1
0 4 8 12 0 4 8 12
Year Year
capital stock raw TFP
1
2
-4 -2 0
-1
Percent
Percent
-3
-6
-5
0 4 8 12 0 4 8 12
Year Year
IV OLS
pegging economies. Full sample: 1890–2015 (World Wars excluded). See text.
36
Figure A2: Post WW2 sample: Real GDP and components
IRFs to a 100 bps trilemma shocks: 1948- 2015
real GDP total hours
1
-2
Percent
Percent
0
-4
-1
-6
0 4 8 12 0 4 8 12
Year Year
capital stock raw TFP
0
0
-2 -1
-2 -1
Percent
Percent
-3
-3
0 4 8 12 0 4 8 12
Year Year
IV OLS
pegging economies. Post-WW2 sample: 1948–2015. See text.
A.2. IRFs with Structural Breaks in GDP per capita

We show an alternate selection of structural breaks based on real GDP per capita.
37
Figure A3: Response to 100 bps trilemma shock with structural breaks: Real GDP
5 breaks in current and expected GDP no structural breaks
Real GDP Real GDP
0
0
-2
-2
-4
Percent
Percent
-4
-6
-6
-8
-8
-10
0 4 8 12 0 4 8 12
Year Year
IV OLS IV OLS
Responses for pegging economies. Full sample: 1890–2015 (World Wars excluded). Post-WW2
sample: 1948–2015. LP-OLS estimates displayed as a dashed red line, LP-IV estimates displayed as
a solid blue line and 1 S.D. and 90% confidence bands. See text and Jordà, Schularick, and Taylor
(2019).
38
Structural Breaks in TFP growth and GDP growth
TFP growth for AUS TFP growth for BEL

10
40
20
0
0
-10
-20
-20
-40
1890 1915 1940 1965 1990 2015 1890 1915 1940 1965 1990 2015
Year Year
TFP growth for CAN TFP growth for CHE

20
30
20
10
10
0
0
-10
-10
-20
1890 1915 1940 1965 1990 2015 1890 1915 1940 1965 1990 2015
Year Year
TFP growth for DEU TFP growth for DNK

50
20
10
0
0
-50
-10
-100
-20
1890 1915 1940 1965 1990 2015 1890 1915 1940 1965 1990 2015
Year Year
TFP growth for ESP TFP growth for FIN

20
10
10
0
-10
0
-10
-20
-30
-20
1890 1915 1940 1965 1990 2015 1890 1915 1940 1965 1990 2015
Year Year
39
TFP growth for FRA TFP growth for GBR
40
5
20
0
0
-5
-20
-40
-10
1890 1915 1940 1965 1990 2015 1890 1915 1940 1965 1990 2015
Year Year
TFP growth for ITA TFP growth for JPN
20
30
0
20
-20
10
-40
0
-10
-60
-20
-80
1890 1915 1940 1965 1990 2015 1890 1915 1940 1965 1990 2015
Year Year
TFP growth for NLD TFP growth for NOR

60
15
10
40
20
5
0
0
-5
-20
-10
-40
1890 1915 1940 1965 1990 2015 1890 1915 1940 1965 1990 2015
Year Year
TFP growth for PRT TFP growth for SWE

15
15
10
10
5
5
0
0
-5
-5
-10
-10
1890 1915 1940 1965 1990 2015 1890 1915 1940 1965 1990 2015
Year Year
40
TFP growth for USA
15
10
5
0
-5
-10
1890 1915 1940 1965 1990 2015

Year
GDP growth for USA

20
10
0
-10
-20
1890 1915 1940 1965 1990 2015

Year
41
20 GDP growth for AUS GDP growth for BEL
40
10
20
0
0
-10
-20
-20
-40
1890 1915 1940 1965 1990 2015 1890 1915 1940 1965 1990 2015
Year Year
GDP growth for CAN GDP growth for CHE

20
15
10
10
5
0
0
-10
-5
-10
-20
1890 1915 1940 1965 1990 2015 1890 1915 1940 1965 1990 2015
Year Year
GDP growth for DEU GDP growth for DNK

50
20
10
0
0
-50
-10
-100
-20
1890 1915 1940 1965 1990 2015 1890 1915 1940 1965 1990 2015
Year Year
GDP growth for ESP GDP growth for FIN

20
10
10
0
0
-10
-10
-20
-30
-20
1890 1915 1940 1965 1990 2015 1890 1915 1940 1965 1990 2015
Year Year
42
GDP growth for FRA GDP growth for GBR
40
10
20
5
0
0
-5
-20
-10
-40
1890 1915 1940 1965 1990 2015 1890 1915 1940 1965 1990 2015
Year Year
GDP growth for ITA GDP growth for JPN
20
20
10
0
0
-10
-20
-20
-30
-40
1890 1915 1940 1965 1990 2015 1890 1915 1940 1965 1990 2015
Year Year
GDP growth for NLD GDP growth for NOR

60
15
40
10
20
5
0
0
-20
-5
-10
-40
1890 1915 1940 1965 1990 2015 1890 1915 1940 1965 1990 2015
Year Year
GDP growth for PRT GDP growth for SWE

10
15
10
5
0
5
-5
0
-10
-5
-10
-15
1890 1915 1940 1965 1990 2015 1890 1915 1940 1965 1990 2015
Year Year
43
A.3. First stage t-statistic for each country
country-wise t-stat of first-stage

w/o controls with controls
15
15
10
10
AVG
AVG
5
5
AUS ESP
JPN AUS
NOR JPN
ESP NOR
GBR
0
0
GBR
0 1.96 5 7.5 10 13 0 1.96 5 7.5 10
Notes: The figures report the first-stage t-statistics for each country during its peg. The change in peg country’s
short term interest rate is regressed on the instrument z. The instrument is the change in base country’s
short term interest which is orthogonal to base country conditions. AVG denotes the t-statistic for the pooled
sample.
44
A.4. Country Specific IRFs over 1890-2015
AUS BEL
20
0
10
-10 -5
Percent
Percent
-10 0
-15
-20
-20
0 4 8 12 0 4 8 12
Year Year
CAN CHE
5
0
-2
0
Percent
Percent
-6 -4
-5
-8
-10
-10
0 4 8 12 0 4 8 12
Year Year
DEU LATE
10
0
-2
5
Percent
Percent
-6 -4
-5 0
-8
-10
-10
0 4 8 12 0 4 8 12
Year Year
IV OLS
45
Percent Percent Percent
-15 -10 -5 0 -10 -5 0 5 10 -5 0 5 10
0
0
0
4
4
4
ITA
FIN
Year
Year
Year
DNK
8
8
8
IV
12
12
12
46
-10 -8 -6 -4 -2 0 -15 -10 -5 0 5 -40 -30 -20 -10 0 10
0
0
0
OLS
4
4
4
ESP
Year
Year
Year
FRA
LATE
8
8
8
12
12
12
-5 0 5 10 -15 -10 -5 0 5 -80 -60 -40 -20 0
0
0
0
4
4
4
JPN
Year
Year
Year
SWE
NOR
8
8
8
IV
12
12
12
47
-10 -8 -6 -4 -2 0 -30 -20 -10 0 10 -20 -15 -10 -5 0 5
0
0
0
OLS
4
4
4
Year
Year
Year
PRT
NLD
LATE
8
8
8
12
12
12
B. Appendix: Graphs Related to Romer and Romer (2004) Surprises
B.1. Different sample selection for US
Figure A4: Response to 100 bps Romer and Romer (2004) shock
(a) Full sample: 1969Q2: 2008Q3 (b) Sample: 1973Q2: 2008Q3
Real GDP .5 (Util. Adj.) TFP index (Fernald 2014) Real GDP (Util. Adj.) TFP index (Fernald 2014)
1
1
.5
1
0
0
Percent
Percent
Percent
Percent
0
0
-1
-.5
-.5
-1
-1
-2
-2
-1
0 8 16 24 32 0 8 16 24 32 0 8 16 24 32 0 8 16 24 32
Quarter Quarter Quarter Quarter
IV OLS IV OLS
Hours, bus sector Capital input Hours, bus sector Capital input
.5
1
0
-.5
0
0
Percent
Percent
Percent
Percent
-.5
-1
-1
-1.5
-1
-1
-2
-1.5
-2
-2
0 8 16 24 32 0 8 16 24 32 0 8 16 24 32 0 8 16 24 32
IV OLS IV OLS
2014), capital stock and hours worked for US economy. Quarterly samples: a) 1969-Q2: 2008-Q3, b) 1973-Q2:
2008-Q3. Quarterly data series are taken from Fernald (2014).
48
(a) Sample: 1979Q3: 2008Q3 (b) Sample: 1984Q1: 2008Q3
Real GDP (Util. Adj.) TFP index (Fernald 2014) Real GDP (Util. Adj.) TFP index (Fernald 2014)
2
1
1
0
Percent
Percent
Percent
Percent
0
-1
-1
-1
-2
-2
-2
-2
-4
-3
0 8 16 24 32 0 8 16 24 32 0 8 16 24 32 0 8 16 24 32
IV OLS IV OLS
3
4
1
2
2
.5
2
1
1
0
Percent
Percent
Percent
Percent
0
0
-.5
0
-2
-1
-1
-1
-1.5
-2
-4
-2
0 8 16 24 32 0 8 16 24 32 0 8 16 24 32 0 8 16 24 32
IV OLS IV OLS
49
(a) Sample: 1969Q2: 2002Q4 (b) Sample: 1987Q1: 2008Q3
Real GDP (Util. Adj.) TFP index (Fernald 2014) Real GDP (Util. Adj.) TFP index (Fernald 2014)
4
2
2
2
1
.5
0
0
0
Percent
Percent
Percent
Percent
0
-2
-1
-2
-.5
-4
-2
-1
-6
-3
-4
0 8 16 24 32 0 8 16 24 32 0 8 16 24 32 0 8 16 24 32
IV OLS IV OLS
2
2
.5
1
0
Percent
Percent
Percent
Percent
-.5
0
0
-2
-1
-1
-1.5
-4
-2
-5
0 8 16 24 32 0 8 16 24 32 0 8 16 24 32 0 8 16 24 32
IV OLS IV OLS
50
C. Appendix: Related Tables
Table A1: LP-OLS vs. LP-IV. Attenuation bias of real GDP per capita responses to interest rates.
Trilemma instrument. Matched samples
Responses of real GDP per capita at years 0 to 10 (100 × log change from year 0 baseline).
(a) Full Sample OLS-IV (b) Post-WW2 OLS-IV
Year LP-OLS LP-IV p-value LP-OLS LP-IV p-value
(1) (2) (3) (4) (5) (6)
h=0 0.07∗∗∗ -0.07 0.09 0.04∗∗ 0.09 0.47
(0.03) (0.09) (0.02) (0.06)
h=2 -0.28∗ -1.72∗∗∗ 0.00 -0.25∗ -1.47∗∗∗ 0.00

(0.16) (0.34) (0.13) (0.38)
h=4 -0.16 -2.53∗∗∗ 0.00 -0.08 -1.83∗∗∗ 0.00

(0.26) (0.50) (0.21) (0.57)
h=6 -0.06 -2.87∗∗∗ 0.00 0.02 -2.37∗∗∗ 0.00

(0.29) (0.66) (0.23) (0.55)
h=8 -0.36 -3.55∗∗∗ 0.00 0.10 -2.04∗∗∗ 0.00

(0.29) (0.84) (0.22) (0.55)
h = 10 -0.40 -4.05∗∗∗ 0.00 0.26 -1.63∗∗∗ 0.00

(0.35) (1.08) (0.24) (0.62)
KP weak IV 79.66 84.86
H 0: LATE = 0 0.00 0.00 0.00 0.00
Observations 607 607 482 482
Notes: ∗∗∗ p < 0.01, ∗∗ p < 0.05, ∗ p < 0.1. Cluster robust standard errors in parentheses.Full sample: 1890 − 2015 excluding
WW1: 1914 − 1919 and WW2: 1939 − 1947. Post WW2 sample: 1948 − 2015. Matched sample indicates LP-OLS sample
matches the sample used to obtain LP-IV estimates. KP weak IV refers to the Kleibergen-Paap test for weak instruments. H0
: subATE = 0 refers to the p-value of the test of the null hypothesis that the coefficients for h = 0, ..., 10 are jointly zero for a
given subpopulation. OLS = IV shows the p-value for the Hausmann test of the null that OLS estimates equal IV estimates.
See text.
51
D. Appendix: DSGE model
D.1. Stationary Allocation

We normalize the following variables :
yt = Yt /Zt
ct = Ct /Zt
k t = Kt /Zt
kut = Ktu /Zt−1
It = It /Zt capital investment
Gt = Gt /Zt Govt Spending
wt = Wt /( Zt Pt )
rtk = Rkt /Pt
λt = Λt Zt
Γt
Γ̃t ≡
Pt Zt
p p
Definition 1 (normalized equilibrium). 19 endogenous variables {λt , gt+1 , it , πt , πtw , X1t , X2t , Xitw ,
w , c , y , z , k u , r K , I , q , u , k , w , L }, 3 shocks { λ g , emp , µ } given the natural rate allocation
X2t t t t t +1 t t t t t t t t t t
f f
variables {yt , gt+1 }.
Consumption Euler Equation
λ t +1 1 + it
1 = βEt (11)
λ t (1 + g t +1 ) π t +1
1 hβ
λt = hct−1
− (12)
ct − ct+1 (1 + gt+1 ) − hct
1+ gt
Price-Setting
 1 −λ p
p λp
X1t 1 − θ p πt
p =  (13)
X2t 1 − θp
1+ λ p
p λp p
X1t = λt yt mct + θ p βπt+1 X1t+1 (14)
1
p 1 p
λt yt + θ p βπt+p 1 X2t+1
λ
X2t = (15)
1 + λp
Wage-Setting
1
!−λw +(1+λw )ν
w
X1t 1 − θw (πtw ) λw
w =
X2t 1 − θw
(16)
− (1+λw,t +1 )(1+ν) (1+λw )(1+ν)

w w 1− ι w
= ωLt 1+ν + θw β (πss w
λw,t+1
X1t ) (πW,t )ιw πW,t+λ1w X1t +1 (17)
52
1 + τw λ −1 1
w w 1− ι w w
X2t = λt wt Lt + θw β (πss ) (πW,t )ιw w,t+1 πW,t
λw
+1 X2t+1 (18)
1 + λw
wt
πW,t = π t (1 + gt ) (19)
w t −1
Capital Investment
It 1 + gt ku

kut+1 = 1 − S It + (1 − δk ) t (20)
It−1 1 + gss 1 + gt

λ t +1
K
qt = βEt r ut+1 − a(ut+1 ) + qt+1 (1 − δk ) (21)
λ t (1 + g t +1 ) t +1
It 1 + gt It 1 + gt It 1 + gt

0
qt 1−S −S
It−1 1 + gss It−1 1 + gss It−1 1 + gss
1 + g t +1 It +1 2 0 It +1 1 + g t +1

λ t +1
+β q t +1 S =1 (22)
λt 1 + gss It It 1 + gss
Capital utilization rate

kut
k t = ut (23)
1 + gt
rtK = a0 (ut ) (24)

Production Technologies
yt = kαt L1t −α (25)
yt
rtk = α (26)
kt
yt
w t = (1 − α ) (27)
Lt
Endogenous Growth
f
gt = log Zt − log Zt−1 = µt + η log(yt−1 /yt−1 ) (28)
Government


ρR φπ !φy 1−ρR !φdy
1 + it 1 + i t −1 π t yt yt /yt−1 1 + gt mp
= 
f

f f f
et (29)
1 + iss 1 + iss πss yt yt /yt−1 1+ gt
Market Clearing !
ku 1
y t = c t + It + a ( u t ) t + 1− g yt (30)
1 + gt λt
Shocks
g g g g
log λt = (1 − ρ g )λ g + ρ g log λt−1 + et ; et ∼ N (0, σg ) (31)
mp
et ∼ N (0, σr ) (32)
53
D.2. Steady State
1 1+i
1=β
(1 + g ) π
(1 + g) − hβ
λ=
c (1 + g − h )
1
mc =
1 + λp
1 + τw
ωL1+ν = λwL
1 + λw
π w = π (1 + g )
q=1
u=1
1 − δk u
(1 − )k = I
1+g

1 K
1=β r + (1 − δk )
1+g
ku
k=
1+g
r K = a 0 (1)
y = k α L 1− α
y
rk = α
k
y
w = (1 − α )
L
g=µ

1
y = c+I+ 1− g y
λ
D.3. Approximate Equilibrium

We log-linearize the variables around the steady state as follows: for any variable x,
x
t
x̂t = log
x
where x is the steady state, except for the following variables

1 + g t +1
ĝt+1 ≡ log
1+g
54

1 + it
ît = log
1 + iss
Definition 2 (Approximate Equilibrium). An approximate competitive equilibrium in this economy
with endogenous growth is defined as a sequence of 16 endogenous variables {λ̂t , ĝt+1 , ît , π̂t , ĉt ,
π̂tw , m̂ct , ŷt , L̂t , ŵt , k̂ut+1 , Ît , q̂t , r̂tK , k̂ t , ût }, which satisfy the following equations, for a given sequence
mp
of one exogenous shock {êt } and given sequence of flexible price allocations.
Consumption Euler Equation
(Et λ̂t+1 − λ̂t − ĝt+1 ) + ît − Et π̂t+1 = 0 (33)

1+g 1+g h
λ̂t = ĝt − (ĉt + ĝt ) − ĉt−1 (34)
1 + g − hβ 1+g−h (1 + g ) − h

hβ 1+g h
+ Et (ĉt+1 + ĝt+1 ) − ĉt
(1 + g) − hβ 1+g−h (1 + g ) − h
Price-Setting
β ιp
π̂t = Et π̂t+1 + π̂t−1 + κ p m̂ct (35)
1 + ιpβ 1 + ιpβ
(1−θ p β)(1−θ p )
where κ p = θ p (1+ ι p β )
.
Wage-Setting
β ιw
π̂tw = Et π̂tw+1 + π̂ w + κw [−λ̂t + ν L̂t − ŵt ] (36)
1 + ιw β 1 + ι w β t −1
(1−θw )(1− βθw )
where κw ≡ >0
θw (1+ι w β)(1+ν(1+ λ1w ))
π̂tw = ŵt − ŵt−1 + π̂t + ĝt (37)
Capital Investment
I 1 − δk h u i
k̂ut+1 = Î t + k̂ − ĝ t +1 (38)
ku 1+g t
rK 1 − δk
q̂t = Et λ̂t+1 − λ̂t − ĝt+1 + r̂tK+1 + K Et q̂t+1

K
(39)
r + (1 − δk ) r + (1 − δk )
q̂t − S00 Ît − Ît−1 + ĝt + βS00 Ît+1 − Ît + ĝt+1 = 0

(40)
parametrize S00 from Smets and Wouters (2007), or Justiniano et al. (2013) to be between 3 and 5.
Capital utilization rate
k̂ t = ût + k̂ut − ĝt (41)
a00 (1)
r̂tK = ût (42)
a 0 (1)
Production Technologies
ŷt = αk̂ t + (1 − α) L̂t (43)
55
r̂tk = ŷt − k̂ t (44)
ŵt = ŷt − L̂t (45)

Endogenous Growth
f
ĝt = µ̂t + η (ŷt−1 − ŷt−1 ) (46)
where η is the hysteresis elasticity
Government
h i h i
f f f f mp
ît = ρ R ît−1 + (1 − ρ R ) φπ π̂ + φy (ŷt − ŷt ) + φdy (ŷt − ŷt−1 ) − (ŷt − ŷt−1 ) + ( ĝt − ĝt ) + êt (47)
Market Clearing
1 c I a 0 (1) k
ŷ t = ĉ t + Î t + ût (48)
λg y y y
56

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The long-run effects of monetary policy ?

Òscar Jordà † Sanjay R. Singh ‡ Alan M. Taylor §

— Of Money in Hume (1758)

2. Data and series construction

2.2. Factor utilization correction

4 SeeJordà, Schularick, and Taylor (2019) for implementation details.

3. Monetary shocks have long lasting effects

3.1. Empirical approach

yi,t+h − yi,t−1 = αi,h + ∆

pegs (q = 1) All years PreWW2 PostWW2

3.2. Main results

h=2 -0.27 -1.63∗∗∗ 0.00 -0.21 -1.42∗∗∗ 0.00

h=4 -0.11 -2.22∗∗∗ 0.00 -0.01 -1.54∗∗ 0.01

h=6 -0.01 -2.55∗∗∗ 0.00 0.11 -2.14∗∗∗ 0.00

h=8 -0.30 -3.47∗∗∗ 0.00 0.18 -2.02∗∗∗ 0.00

h = 10 -0.33 -4.20∗∗∗ 0.00 0.35 -1.68∗∗∗ 0.00

h = 12 -0.58 -6.77∗∗∗ 0.00 0.24 -2.62∗∗∗ 0.00

(a) Full sample (b) Post-WW2

Real GDP Real GDP

(a) Full sample (b) Post-WW2

(a) Full sample (b) Post-WW2

Raw TFP Util adj TFP K utilization L utilization

(a) Full sample (b) Post-WW2

K / Util adj TFP K / Util adj TFP

(a) Full sample (b) Post-WW2

(a) Full sample (b) Post-WW2

Real interest rate multiplier Real interest rate multiplier

4. Threats to identification and robustness

4.1. Open economy threats to Identification

ated with the global financial cycle (Rey, 2015).

4.1.1 Textbook specification with hard pegs

4.1.2 Financial spillovers with dirty float policy

(1 + a)∆Y = −c∆R + a∆Y ∗ + (b − f )∆E

4.2. Spillover correction for the trilemma instrument

Real GDP Real GDP

4.2.1 Synthetic control function approach

4.2.2 Orthogonalized interest rate channel

(a) Full sample (b) Post-WW2

Real GDP Real GDP

IV OLS IV spillover corrected

yi,t+h − yi,t−1 = αi,h + ∆r

where Gt+h is global GDP growth at time t + h.

4.3. Accounting for structural breaks

Real GDP Real GDP

yi,t+h − yi,t−1 = αi,h + ∑ ( Di,k,t + Di,k,t+h ) + ∆r

4.4. Levels, differences, and number of lags

5 breaks in TFP and expected TFP no breaks in TFP

Real GDP Real GDP

Real GDP: controls in levels Real GDP: controls in differences

Monte Carlo Simulation: AR(2) and AR(4) vs LP (2)

AR(4) response LP(2) response

4.5. Why might VARs not find persistent effects?

4.6. Is the US different?

Real GDP (Util. Adj.) TFP index (Fernald 2014)

Hours, bus sector Capital input

Instrument: Romer & Romer (2004) residuals

GDP Util adj TFP K L LQ

5.1. Monopolistically competitive producers

subject to demand for its product

− (1+λw,t +1 )(1+ν) (1+λw )(1+ν)