In the current global economic situation, the Federal Reserve's monetary policy is under unprecedented scrutiny. Despite policy interest rates reaching historic highs, the U.S. economy remains strong, a phenomenon that seems to contradict traditional economic theory. The ongoing strength of the job market and steady economic growth raises questions: why has tight monetary policy failed to effectively curb economic overheating as it has in the past? Recent research suggests that this phenomenon is not a paradox but rather a limitation of traditional analytical frameworks. By re-examining the impact of financial conditions on the economy, we can gain a deeper understanding of the actual transmission mechanism of monetary policy.
The Federal Reserve has raised interest rates to historic levels, yet the economy continues to thrive. The strong employment report currently is proof of this. Why is this happening?
According to our latest paper, perhaps we are focusing on the wrong indicators.
Although policy interest rates are high, the financial environment is actually quite loose. The rise in the stock market and the tightening of credit spreads effectively offset much of the Federal Reserve's tightening policy.
Data shows that the FCI-G index designed by the Federal Reserve (a composite financial variable to measure its impact on economic growth) confirms this. While long-term interest rates are rising and the dollar is strengthening, the positive market performance (mainly the stock market boom and the improvement of credit spreads) is stimulating economic growth.
Tight monetary policy and strong growth are not actually a paradox.
In our research with Ricardo Caballero and @TCaravello, we indicate that what matters for the economy is not the policy interest rate itself, but broader financial conditions.
Our analysis shows that when the financial environment loosens, even if driven by noisy asset demand (sentiment), it can stimulate output and inflation, ultimately forcing interest rates to rise. This aligns with the situation we see today.
From a quantitative perspective, research has found that the impact of financial conditions on economic output fluctuations accounts for as much as 55%.
Moreover, the primary transmission mechanism of monetary policy should be to influence financial conditions rather than acting directly through interest rates.
The current situation fits this framework: despite high interest rates, loose financial conditions are supporting strong growth and may prevent inflation from returning to target levels.
Looking ahead, this suggests that the Federal Reserve's task is not yet complete. To achieve the 2% target, financial conditions may need to tighten.
This may be achieved in the following way: market adjustment - dollar strengthening - further interest rate hikes.
The path of interest rates will largely depend on market dynamics. If the market adjusts and the dollar strengthens, the current level of interest rates may be sufficient. However, if financial conditions remain loose, further interest rate hikes may be necessary.
This framework suggests that observers of the Federal Reserve should focus less on the debate around the 'terminal rate' and more on the evolution of financial conditions. This is where the real monetary policy transmission occurs.
While our paper further proposes clear FCI targets, more importantly, we need to change the way we think and talk about monetary policy. The policy interest rate is just one input; financial conditions are what truly matters.
#美国PPI温和上涨 #哪些代币逆势上涨？ #Mlion投研工具