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Financial Conditions Targeting

Author

Listed:
  • Ricardo J. Caballero
  • Tomás E. Caravello
  • Alp Simsek

Abstract

Non-fundamental inflows into the stock market loosen financial conditions and raise output, while the policy rate responds gradually. Such financial noise explains up to 20% of the variance of financial conditions and output. These facts motivate a macroeconomic model with noise traders, risk-averse arbitrageurs, and gradual interest rate adjustment. In this model, Financial Conditions Index (FCI) targeting can improve macroeconomic stabilization: the central bank announces its expected FCI as a soft near-term target and adjusts the policy rate to keep conditions near it. This commitment reduces FCI volatility, thereby “recruiting” arbitrageurs to insulate the FCI and aggregate demand from noise.

Suggested Citation

  • Ricardo J. Caballero & Tomás E. Caravello & Alp Simsek, 2024. "Financial Conditions Targeting," NBER Working Papers 33206, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:33206
    Note: AP EFG ME
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    Cited by:

    1. Chen, Zhengyang, 2026. "Demystifying monetary policy surprises: Fed response to financial conditions and wait and see for new economic data," Journal of Macroeconomics, Elsevier, vol. 87(C).

    More about this item

    JEL classification:

    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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