US tightening had limited effect due to demand, credit channel
A Bank of Japan working paper investigates the resilience of the U.S. economy despite rapid monetary policy tightening since 2022. The study attributes this to demand composition and the time-varying nature of the credit channel.
Demand composition dampens rate hike impact
The study reveals that monetary policy tightening significantly dampens demand components with high borrowing reliance, such as durable goods consumption and housing investment.
Conversely, components with lower borrowing dependence, including service consumption and intangible asset investments, exhibit muted responses.
This heterogeneity suggests that the growing dominance of service consumption and intangible assets in the U.S. economy, termed the 'composition effect,' can explain the limited aggregate demand response to recent rate hikes.
The Factor-Augmented VAR (FAVAR) model, utilizing approximately 100 time series, was employed to identify these differential effects across GDP demand components.
Credit channel's varying amplification role
The paper further demonstrates that the effectiveness of monetary policy is amplified for borrowing-dependent components only when the credit channel is strongly operative.
This 'regime effect' is quantified using a smooth-transition Local Projection (ST-LP) model, with the excess bond premium (EBP) serving as a transition variable reflecting financial market conditions.
When the credit channel's amplification role is subdued, even highly borrowing-dependent components show weaker reactions.
This mechanism helps explain the overall resilience of the U.S. economy during the recent tightening cycle.
Resilience explained, but not fully
This research offers a compelling, unified framework for understanding the U.S. economy's resilience to recent monetary tightening.
While methodologically robust, the paper acknowledges that other factors like fiscal policy and supply constraints also play a role.
Its findings provide crucial empirical grounding for ongoing debates on the evolving nature of monetary policy transmission.