Is Less More?: Menu Costs and Estimated Thresholds in the Response of Output to Monetary Policy

This paper investigates asymmetries in the response of output to monetary policy shocks of different magnitude. Traditionally in the literature, the threshold determining which shocks are ‘large ’ and which are ‘small ’ has been imposed exogenously. To the extent that such a threshold is misspecified, tests for asymmetry will have low power. In this context, an unobserved components (UC) model of output with a TAR-driven transitory component augmented by a monetary policy variable is estimated. This framework makes it possible to introduce the threshold determining the size of monetary policy shocks as an additional parameter, instead of imposing an ad hoc definition. When the threshold is estimated from the data, there is strong statistical evidence that the response of output to monetary shocks of different size behaves asymmetrically. Moreover, the results found show some support for the implications of menu-cost models