Working papers are academic research by SF Fed economists and affiliates intended for publication in scholarly journals. This section contains working papers on monetary economics and macro-finance topics that have been authored or co-authored by SF Fed Economists.
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Accounting for Uncertainty and Risks in Monetary Policy
Michael Bauer, Travis Berge, Giuseppe Fiori, Francesca Loria, Molin Zhong
This paper discusses the measurement, assessment, and communication of risks and uncertainty that are relevant for monetary policy. It provides a taxonomy of policy-relevant uncertainty related to the state and the structure of the economy, and the formation of expectations. A wide range of tools is available to assess and quantify uncertainty and the balance […]
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Evaluating Macroeconomic Outcomes Under Asymmetries: Expectations Matter
Brent Bundick, Isabel Cairo, Nicolas Petrosky-Nadeau
Asymmetries play an important role in many macroeconomic models. We show that assumptions on household and firm expectations play a key role in determining the effects of these asymmetries on macroeconomic outcomes. If households and firms have perfect foresight and hence do not account for the possibility of future shocks, then the implied longer-run averages and distributions for unemployment and inflation can differ significantly from their rational expectations counterparts. We first derive this result analytically under either an asymmetric monetary policy rule or a nonlinear Phillips curve before numerically examining some of the key nonlinearities featured in the recent literature.
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Inflation Since the Pandemic: Lessons and Challenges
Ina Hajdini, Adam Shapiro, A. Lee Smith, Daniel Villar
This paper reviews the drivers of the post-pandemic U.S. inflation surge and subsequent decline, including the behavior and role of inflation expectations. The sharp rise in inflation reflected severe imbalances between supply and demand stemming from the shocks of the pandemic and the policy response. Measures of short-term inflation expectations increased alongside realized inflation, especially those of households and firms, which may have contributed to inflation’s persistence through price- and wage-setting behavior. However, measures of longer-term inflation expectations remained generally well anchored, which likely prevented a larger or more lasting increase in inflation. The stability of longer-term inflation expectations, together with easing supply and demand imbalances, allowed inflation to fall from its peak in mid-2022 without a large increase in unemployment. We conclude by reviewing some lessons learned from this episode as well as potential risks to inflation going forward.
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A Tale of Two Tightenings
Simon H. Kwan, Ville Voutilainen
Both the magnitude and the pace of monetary policy tightening in the euro area during 2022-23 were historically large and fast. Yet, the real economy proved to be resilient. In this paper, we analyze the pass through of the ECB’s changes in the policy rate to mortgage rates in Finland during the post-pandemic period of 2022-23, when the policy liftoff began at the negative interest rate territory, using the normal tightening cycle in 2006-08 as control. We use monthly data and three different empirical methodologies: event studies, high-frequency identification, and exposure-measure regressions. Our evidence suggests that the post-pandemic monetary policy transmission was significantly less effective than during the control period, implying that for the same amount of tightening in financial conditions, a bigger increase in the policy rate is needed. The loss in monetary transmission during the negative interest rate policy is also playing out when monetary policy changes course. Thus, while monetary policy remains effective in the negative interest rate territory, it creates headwind for policy normalization down the road.
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Asset Purchases in a Monetary Union with Default and Liquidity Risks
Huixin Bi, Andrew Foerster, Nora Traum
Using a two-country monetary union framework with financial frictions, we quantify the efficacy of targeted asset purchases, as well as expectations of such programs, in the presence of sovereign default and financial liquidity risks. The risk of default increases with the level of government debt and shifts in investors’ perception of fiscal solvency. Liquidity risks […]
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Demand versus Supply: Which is More Important for Inflation?
Kevin J. Lansing
The author uses Phillips curve type regressions to assess the relative contributions of demand and supply forces to U.S. inflation during the pandemic era from February 2020 onward and the decade following the end of the Great Recession. In the first specification (Model 1), demand and supply forces are measured using the vacancy-unemployment ratio and the New York Fed’s Global Supply Chain Pressure Index, respectively. In the second specification (Model 2), demand and supply forces are measured using the demand-driven and supply-driven components of PCE inflation from Shapiro (2025). The results derived from the two models are largely in agreement. For both models, variance decompositions imply that demand forces became more important for inflation during the pandemic era and dominated the influence of supply forces. In counterfactual simulations, both models imply that supply forces, together with the endogenous response of expected inflation, were the primary drivers of persistently low inflation after the Great Recession. Given that monetary policy operates to influence demand-driven inflation, this result helps to account for the Fed’s difficulty in achieving its 2% inflation goal during these years.
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The Bank Lending Channel Is Back
Mark M. Spiegel
The period following the global financial crisis was marked by low interest rates and low responsiveness of bank lending to monetary policy. This led some to conclude that the bank lending channel for monetary policy to influence economic activity had weakened. This paper revisits the responsiveness of the bank lending channel using a bank-level panel of US Call Report data and updated measures of U.S. monetary policy shocks. Results indicate that the efficacy of the bank lending channel increased over our sample period. We find tepid responses in bank lending to monetary shocks from 2012H1 through 2016H2, matching the existing literature, but significantly more robust responsiveness after liftoff, represented by the latter portion of our sample from 2017H1 through 2023H2. Separating the later panel by bank size reveals that the bank lending channel is larger for small and medium-sized banks than for large banks over this later period, also consistent with studies predating the global financial crisis. Increases in responsiveness at conventional rates are even greater for small business lending. An interactive specification over our entire sample period confirms that the stronger recent bank lending responses to monetary policy shocks are associated with sufficiently high prevailing levels of the federal funds rate.
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Green Stocks and Monetary Policy Shocks: Evidence from Europe
Michael Bauer, Eric Offner, Glenn D. Rudebusch
Policymakers and researchers worry that the low-carbon transition may be inadvertently delayed by higher global interest rates. To examine whether green investment is especially sensitive to interest rate increases, we consider the effect of unanticipated monetary policy changes on the equity prices of green and brown European firms. We find that brown firms, measured in terms of carbon emission levels or intensities, are more negatively affected than green firms by tighter monetary policy. This heterogeneity is robust to different monetary policy surprises, emission measures, econometric methods, and sample periods, and it is not explained by other firm characteristics. This evidence suggests that higher interest rates may not skew investment away from a sustainable transition.
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A Simple Measure of Anchoring for Short-Run Expected Inflation in FIRE Models
Peter Lihn Jorgensen, Kevin Lansing
We show that the fraction of non-reoptimizing firms that index prices to the inflation target, rather than lagged inflation, provides a simple measure of anchoring for short-run expected inflation in a New Keynesian model with full-information rational expectations. Higher values of the anchoring measure imply less sensitivity of rational inflation forecasts to movements in actual inflation. The approximate value of the model’s anchoring measure can be inferred from observable data generated by the model itself, as given by 1 minus the autocorrelation statistic for quarterly inflation. We show that a shift in the collective indexing behavior of firms allows the model to account for numerous features of evolving U.S. inflation behavior since 1960.
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A Currency Premium Puzzle
Tarek A. Hassan, Thomas Mertens, Jingye Wang
Standard asset pricing models reconcile high equity premia with smooth risk-free rates by inducing an inverse functional relationship between the mean and the variance of the stochastic discount factor. This highly successful resolution to closed-economy asset pricing puzzles is fundamentally problematic when applied to open economies: It requires that differences in currency returns arise almost exclusively from predictable appreciations, not from interest rate differentials. In the data, by contrast, exchange rates are largely unpredictable, and currency returns arise from persistent interest rate differentials. We show currency risk premia arising in canonical long-run risk and habit preferences cannot match this fact. We argue this tension between canonical asset pricing and international macroeconomic models is a key reason researchers have struggled to reconcile the observed behavior of exchange rates, interest rates, and capital flows across countries. The lack of such a unifying model is a major impediment to understanding the effect of risk premia on international markets.