Which levels of interest rates along the yield curve are consistent with stable economic activity? We use expectations at the daily frequency reflected in financial market prices to extract the state of the economy within a textbook New Keynesian model. We use these real-time estimates to derive neutral and optimal monetary policy rates at each horizon. The model identifies perceived demand and supply shocks on each day, along with their persistence and associated risk premiums. We find that financial markets started to predict the post-COVID surge in inflation by mid-2021 and inflation risk premiums turned positive soon thereafter. The resulting inflation forecasts from the model are at least as accurate as several leading alternatives.
Suggested citation:
Mertens, Thomas M., and Tony Zhang. 2025. “A Financial New Keynesian Model.” Federal Reserve Bank of San Francisco Working Paper 2023-35. https://doi.org/10.24148/wp2023-35