Template-Type: ReDIF-Paper 1.0
Author-Name: Marco Jacopo Lombardi
Author-X-Name-First: Marco Jacopo
Author-X-Name-Last: Lombardi
Author-Name: Cristina Manea
Author-X-Name-First: Cristina
Author-X-Name-Last: Manea
Author-Name: Andreas Schrimpf
Author-X-Name-First: Andreas
Author-X-Name-Last: Schrimpf
Title: Financial conditions and the macroeconomy: a two-factor view
Abstract: We construct a new financial conditions index for the United States based on a dynamic factor model applied to a broad set of financial prices and yields. The resulting two latent factors capture, respectively, the general level of safe interest rates and an overall measure of perceived and priced financial risk. Analysing the interaction between these factors and the macroeconomy, we find that: (i) both factors are affected significantly by monetary policy; (ii) positive shifts in both factors lead to a persistent contraction in economic activity; (iii) relative to the safe interest rates factor, the risk–related factor exhibits stronger predictive power for economic activity. Our results are consistent with both the demand and the credit channels of monetary policy being at work, and emphasize that isolating movements in safe interest rates from shifts in perceived financial risk is essential to accurately assess the transmission of financial conditions to economic activity.
Creation-Date: 2025-06
File-URL: https://www.bis.org/publ/work1272.pdf
File-Format: Application/pdf
File-Function: Full PDF document
File-URL: https://www.bis.org/publ/work1272.htm
File-Format: text/html
Number: 1272
Keywords: financial conditions, monetary policy, financial accelerator, dynamic factor model
Classification-JEL: C38, E52, G10
Handle: RePEc:bis:biswps:1272