Measuring monetary policy shocks and their effects in an emerging economy: the case of Brazil

Abstract We estimate novel narrative monetary policy shocks for Brazil, derived from the Central Bank’s reaction function and accounting for both constant and time-varying systematic monetary policy. We then examine the effects of these shocks on Brazilian macroeconomic variables using structural vector autoregressions with external instruments. Our results indicate a reduction in the magnitude and volatility of monetary surprises after 2004, reflecting increased predictability in the Brazilian monetary authority’s actions. The impulse response estimates provide some evidence that unexpected interest rate hikes are associated with reductions in output and in the monetary aggregate M1, as well as with increases in the unemployment rate. By contrast, monetary policy shocks appear to leave exchange rates and stock prices unaffected. A transient price puzzle arises within six months of the shock, but models including core inflation generally produce a negative and more lasting effect of monetary tightening on inflation. These results highlight the complexities of monetary policy transmission in emerging markets.