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Shaping the future: Policy shocks and the GDP growth distribution

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When central banks lower interest rates or governments boost spending during economic downturns, they aim to improve the outlook. But can those policies also change the risks around the outlook by, for example, avoiding the worst possible outcomes that may have only a small chance of occurring?

To answer this, we build a new framework to empirically assess how monetary and fiscal policy influence the possibility of future GDP growth being stronger (upside risk) or weaker (downside risk) than what we would normally expect. Instead of assuming the usual balanced and symmetrical risks around the outlook, we explicitly model the changes of future GDP growth that are less likely to occur.

We find that accommodative monetary policy increases future GDP growth but doesn’t significantly change the relative odds of having much stronger or much weaker GDP growth. In contrast, fiscal stimulus does increase the odds of faster GDP growth by increasing upside risks more than it reduces downside risks. The effect is stronger when monetary policy is constrained by the zero lower bound. Our results suggest that fiscal stimulus is well suited to accelerate the recovery phase of the COVID-19 pandemic.