THE IMPACT OF FEDERAL RESERVE POLICY ON THE FED’S FINANCIAL CONDITIONS INDEX

Abstract

The Federal Reserve conducts monetary policy by setting a target range for the federal funds rate, the interest rate at which banks borrow and lend to each other overnight. However, the federal funds rate by itself does not directly affect most firms and households in the economy. Instead, monetary policy is transmitted to the broader economy by affecting financial conditions more generally, including the longer-term interest rates at which businesses and households borrow, the exchange value of the dollar, and the prices of key assets such as equities and real estate. It is thus important to assess how these broader financial conditions are affected by the Fed’s monetary policy decisions. The purpose of this paper is to measure that effect and to summarize it with a simple benchmark that should prove useful both for assessing the stance of monetary policy and forecasting economic activity.