Modest policy interventions

We present a theoretical and empirical framework for computing and evaluating linear projections conditional on hypothetical paths of monetary policy. A modest policy intervention does not significantly shift agents' beliefs about policy regime and does not induce the changes in behavior that Lucas (Carnegie-Rochester Conference Series on Public Policy, Vol. 1, Amsterdam, North-Holland, 1976, pp. 104-130) emphasizes. Applied to an econometric model of U.S. monetary policy, we find that a rich class of interventions routinely considered by the Federal Reserve is modest and their impacts can be reliably forecasted by an identified linear model. Modest interventions can shift projected paths and probability distributions of macro variables in economically meaningful ways. (C) 2003 Elsevier B.V. All rights reserved.