We construct a new high-frequency measure of risk appetite shifts around Federal Open Market Committee (FOMC) meetings, the common component of changes in risk-sensitive indicators. Fed policy actions and communication have substantial effects on risk appetite. Interest-rate surprises explain only about one-fifth of the variation in risk appetite, so most policy-induced changes in risk asset prices are orthogonal to the expected rate path. We therefore use both surprises as external instruments in a proxy SVAR with two separately identified shocks. Risk appetite shocks have large and persistent contractionary effects, lowering output and prices while raising unemployment. By contrast, the effects of risk-free rate shocks tend to be small and imprecisely estimated, and some have puzzling signs. Monetary transmission appears to operate primarily through risk appetite and risk asset prices. Estimates relying on interest-rate surprises alone miss most of these effects, for two reasons: the link from interest rates to risk appetite is state-dependent, and Fed communication moves it independently of the expected rate path.
Suggested citation:
Bauer, Michael, Maik Schmeling, and Andreas Schrimpf. 2026. “Risk Appetite and Monetary Transmission” Federal Reserve Bank of San Francisco Working Paper 2026-20. https://doi.org/10.24148/wp2026-20