Search Results
Working Paper
Financial Stability Considerations for Monetary Policy: Theoretical Mechanisms
This paper reviews the theoretical literature at the intersection of macroeconomics and finance to draw lessons on the connection between vulnerabilities in the financial system and the macroeconomy, and on how monetary policy affects that connection. This literature finds that financial vulnerabilities are inherent to financial systems and tend to be procyclical. Moreover, financial vulnerabilities amplify the effects of adverse shocks to the economy, so that even a small shock to fundamentals or a small revision of beliefs can create a self-reinforcing feedback loop that impairs credit ...
Working Paper
Financial Stability and Optimal Interest-Rate Policy
We study optimal interest-rate policy in a New Keynesian model in which the economy can experience financial crises and the probability of a crisis depends on credit conditions. The optimal adjustment to interest rates in response to credit conditions is (very) small in the model calibrated to match the historical relationship between credit conditions, output, inflation, and likelihood of financial crises. Given the imprecise estimates of key parameters, we also study optimal policy under parameter uncertainty. We find that Bayesian and robust central banks will respond more aggressively to ...
Report
Financial Stability Considerations for Monetary Policy: Theoretical Mechanisms
This paper reviews the theoretical literature at the intersection of macroeconomics and finance to draw lessons on the connection between vulnerabilities in the financial system and the macroeconomy, and on how monetary policy affects that connection. This literature finds that financial vulnerabilities are inherent to financial systems and tend to be procyclical. Moreover, financial vulnerabilities amplify the effects of adverse shocks to the economy, so that even a small shock to fundamentals or a small revision of beliefs can create a self-reinforcing feedback loop that impairs credit ...
Journal Article
No-arbitrage restrictions and the U.S. Treasury market
What is the role of arbitrage trading in the U.S. Treasury market? In this article, the authors discuss the pricing of risk-free Treasury securities via no-arbitrage arguments and illustrate how this approach works in models of the term structure of interest rates. The article ends with an evaluation of market frictions (for example, transaction costs, leverage constraints, and the limited availability of arbitrage capital) in the government debt market and their implications for bond pricing using no-arbitrage term structure models.
Working Paper
More than Words: Twitter Chatter and Financial Market Sentiment
We build a new measure of credit and financial market sentiment using Natural Language Processing on Twitter data. We find that the Twitter Financial Sentiment Index (TFSI) correlates highly with corporate bond spreads and other price- and survey-based measures of financial conditions. We document that overnight Twitter financial sentiment helps predict next day stock market returns. Most notably, we show that the index contains information that helps forecast changes in the U.S. monetary policy stance: a deterioration in Twitter financial sentiment the day ahead of an FOMC statement release ...
Working Paper
Financial Market Effects of FOMC Communication: Evidence from a New Event-Study Database
This paper introduces the U.S. Monetary Policy Event-Study Database (USMPD), a novel, public, and regularly updated dataset of financial market data around Federal Open Market Committee (FOMC) policy announcements, press conferences, and minutes releases. Using the rich high-frequency data in the USMPD, we document several new empirical findings. Large monetary policy surprises have made a comeback in recent years, and post-meeting press conferences have become the most important source of policy news. Monetary policy surprises have pronounced negative effects on breakeven inflation based on ...
Journal Article
The Asymmetric Costs of Misperceiving R-star
The natural rate of interest, or r-star, is used to evaluate whether monetary policy is restrictive or supportive of economic activity. However, this benchmark rate can only be estimated, and policymakers’ misperceptions of the level of the natural rate can carry substantial economic costs in terms of unemployment and inflation. A scenario using mistaken perceptions shows that the costs of overestimating the natural rate are greater than the cost of underestimating it if policy space is limited by the effective lower bound on the nominal federal funds rate.
Discussion Paper
Financial Conditions and Risks to the Economic Outlook
Financial conditions have swung considerably over the past two and half years. They moved from very accommodative levels in late 2021 to providing a significant drag on economic activity in 2022 and 2023. Since early this year, they eased moderately amid monetary policy communications signaling that the federal funds rate had likely reached its peak for this monetary policy tightening cycle.