Eric M. Leeper and Tao Zha
Working Paper 2002-19
November 2002

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The authors present a framework for computing and evaluating linear projections of macro variables conditional on hypothetical paths of monetary policy. A modest policy intervention is a change in policy that does not significantly shift agents’ beliefs about policy regime and does not generate quantitatively important expectations-formation effects of the kind Lucas (1976) emphasizes. The framework is applied to an econometric model of U.S. postwar monetary policy behavior. It finds that a rich class of interventions routinely considered by the Federal Reserve are modest and their impacts can be reliably forecast by an accurately identified linear model. Moreover, modest interventions can matter: They may shift the projected paths and probability distributions of macro variables in economically meaningful ways.

JEL classification: E52; E47; C53

Keywords: monetary policy, identification, forecasting, policy analysis, VAR, Lucas critique

The authors thank Ralph Bryant, Peter Clark, Tom Cooley, Jon Faust, John Geweke, Ross Levine, Adrian Pagan, Peter Pedroni, Tom Sargent, Anders Vredin, Mike Woodford, and especially David Gordon, Chris Sims, and Dan Waggoner for helpful suggestions. The views expressed here are the authors’ and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors’ responsibility.

Please address questions regarding content to Eric M. Leeper, Indiana University, Department of Economics, 304 Wylie Hall, Bloomington, Indiana 47405, and NBER; or Tao Zha, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street, N.E., Atlanta, Georgia 30309-4470,