Monetary Policy Stance Is Tighter than Federal Funds Rate
The Federal Reserve’s use of forward guidance and balance sheet policy means that monetary policy consists of more than changing the federal funds rate target. A proxy federal funds rate that incorporates data from financial markets can help assess the broader stance of monetary policy. This proxy measure shows that, since late 2021, monetary policy has been substantially tighter than the federal funds rate indicates. Tightening financial conditions are similar to what would be expected if the funds rate had exceeded 5¼% by September 2022.
The Evolution of Disagreement in the Dot Plot
The Summary of Economic Projections offers important insights into the views of Federal Open Market Committee participants. The summary’s “dot plot” charts each participant’s assessment of the appropriate path for monetary policy given their economic outlook. A new index measuring the level of disagreement indicated by the dots shows that disagreement fell during the 2010s expansion, was nearly nonexistent early in the pandemic, and has been increasing recently. Policy disagreement is correlated with disagreement about future inflation, but factors unrelated to disagreement about the ...
Permanent and Transitory Effects of the 2008–09 Recession
Separating U.S. economic output into permanent and transitory components can help explain the effects of recessions and expansions. GDP growth shifted to a lower trend rate in 2000, indicating a slowdown long before the 2008–09 recession. GDP was substantially above trend before that recession; it then declined significantly and did not recover to its trend rate until 2017. The recession resulted in permanent losses to GDP. Without those permanent effects, GDP at the end of the latest expansion would have been about $380 billion or $1,460 per person higher.
Expectations of large-scale asset purchases
During and after the recent financial crisis, the Federal Reserve turned to a number of unconventional tools to bolster the economy. The effectiveness of one such tool, large-scale asset purchases (LSAPs)?often referred to as quantitative easing?has been hard to measure. ; Efforts to estimate LSAP impact have often relied on an "event study" approach, focusing on short time intervals around the announcements of new LSAP programs. But these studies typically ignore the fact that financial market participants sometimes expect a given LSAP announcement in advance?and such expectations can ...
Optimal Monetary Policy Regime Switches
An economy that switches between high and low growth regimes creates incentives for the monetary authority to change its rule. As lower growth tends to produce lower real interest rates, the monetary authority has an incentive to increase the inflation target and increase the degree of inertia in setting rates in an attempt to keep the nominal rate away from the zero lower bound. An optimizing monetary authority therefore responds to permanently lower growth by slightly increasing both the inflation target and inertia; focusing solely on the inflation target ignores a key margin of ...
Why Is the Fed’s Balance Sheet Still So Big?
The Federal Reserve?s balance sheet is significantly larger today than it was before the financial crisis of 2008?2009. Rising demand for currency due to greater economic activity is partly responsible for this increase. The balance sheet will also need to remain large because the Federal Reserve now implements monetary policy in a regime of ample reserves, using a different set of tools than in the past to achieve its interest rate target.
Estimating Macroeconomic Models of Financial Crises: An Endogenous Regime-Switching Approach
We estimate a workhorse DSGE model with an occasionally binding borrowing constraint. First, we propose a new specification of the occasionally binding constraint, where the transition between the unconstrained and constrained states is a stochastic function of the leverage level and the constraint multiplier. This specification maps into an endogenous regime-switching model. Second, we develop a general perturbation method for the solution of such a model. Third, we estimate the model with Bayesian methods to fit Mexico's business cycle and financial crisis history since 1981. The estimated ...
Perturbation methods for Markov-switching DSGE models
This paper develops a general perturbation methodology for constructing high-order approximations to the solutions of Markov-switching DSGE models. We introduce an important and practical idea of partitioning the Markov-switching parameter space so that a steady state is well defined. With this definition, we show that the problem of finding an approximation of any order can be reduced to solving a system of quadratic equations. We propose using the theory of Grobner bases in searching all the solutions to the quadratic system. This approach allows us to obtain all the approximations and ...
Sudden Stops and COVID-19: Lessons from Mexico’s History
The COVID-19 pandemic produced a sharp contraction in capital flows in emerging markets during the spring of 2020. Such contractions are known as “sudden stops” and historically have been associated with significant downturns in a country’s economic activity. Evidence from Mexico’s financial crisis history suggests that sudden stops tend to exhibit a common pattern: the crisis lasts one to two years before a rapid but partial recovery, followed by years of protracted stagnation.
Have Lags in Monetary Policy Transmission Shortened?
The Federal Open Market Committee’s monetary policy has expanded beyond changing the federal funds rate to include forward guidance and balance sheet policy. Using these tools may shorten lags in monetary policy transmitting to inflation. Using a proxy funds rate that incorporates tightening from these additional policy tools, we find evidence of a shorter lag in policy transmission to inflation since 2009, though with high associated uncertainty.