Analyzing the Dynamic Impact of Monetary Policy Shocks on Inflation and Unemployment

ANALYZING THE DYNAMIC IMPACT OF MONETARY POLICY SHOCKS ON INFLATION AND UNEMPLOYMENT

Abstract

This paper investigates the dynamic impact of monetary policy shocks on inflation and unemployment using a Structural Vector Autoregression (SVAR) framework. Using high-frequency data obtained from the Federal Reserve Economic Data (FRED) database, the study examines the transmission mechanism of changes in the Federal Funds Rate and their effects on key macroeconomic indicators. The research employs econometric techniques including the Augmented Dickey-Fuller (ADF) test for stationarity, lag selection based on the Akaike Information Criterion (AIC), and the estimation of Impulse Response Functions (IRFs) to analyze the dynamic relationships among the variables.

The empirical findings demonstrate that a contractionary monetary policy shock results in a temporary increase in unemployment followed by a gradual decline in inflation, providing quantitative evidence of the trade-offs central banks face while pursuing price stability and economic growth. The study highlights the delayed but significant effects of interest rate adjustments on macroeconomic performance.

Further analysis using model stability tests and Forecast Error Variance Decomposition (FEVD) confirms the robustness of the SVAR model and underscores the importance of monetary policy shocks in explaining fluctuations in inflation and unemployment. The paper contributes to the understanding of monetary policy transmission mechanisms and offers valuable insights for policymakers seeking to balance inflation control with employment objectives.

Authors

Anamika Singh, Nitesh Kumar, Piyush Raj, Prince Kumar, Priti Singh

Institution

Noida Institute of Engineering & Technology (MCA Institute), Greater Noida, India

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