New Perspectives on Business Cycles and Monetary Policy
Paper Session
Sunday, Jan. 3, 2027 8:00 AM - 10:00 AM (EST)
- Chair: Johannes Wieland, University of California-San Diego and NBER
Central Banks and Financial Instability
Abstract
Across history, central banks have used their balance sheets as lenders of last resort (LLR) to stabilize the financial system during crises. We study the evolution and fluctuation of central bank balance sheets since the 1600s and assess the aggregate effects of liquidity interventions. Using plausibly exogenous variation in the likelihood of crisis interventions induced by ex ante beliefs of central bank governors allows us to show that LLR interventions systematically mitigate financial crises and accelerate macroeconomic recoveries. However, we also present evidence that such interventions raise risks of future boom-bust cycles in the financial system.Frost and Fire: A Tale of Two Crises
Abstract
Financial crises are characterized by depressed asset prices, tight financial constraints, and misallocation of resources. Standard policy responses—such as asset purchases and low interest rates—are generally intended to alleviate these symptoms. This paper distinguishes between two types of crises that appear similar but differ fundamentally in their underlying mechanisms: fire-sale crises, where productive firms are forced to sell assets; and demand-freeze crises, where productive firms are unable to purchase assets. While both lead to similar observable outcomes, they have contrasting general-equilibrium effects and may call for different policy interventions. Notably, conventional policies can be counterproductive in demand-freeze crises, as they may exacerbate financial constraints and further distort resource allocation. Empirical evidence on the pattern of capital reallocation among U.S. firms suggests that demand-freeze crises are, in fact, more common.FCI-plot: Central Bank Communication Through Financial Conditions
Abstract
Monetary policy is transmitted to the real economy primarily through financial conditions. We document that financial market participants routinely disagree with the central bank about the near-term macroeconomic outlook and are uncertain about the appropriate financial conditions even conditional on their own outlook. We develop a model consistent with these features and use it to analyze optimal central bank communication. In the model, arbitrageurs disagree with the central bank about the outlook and are uncertain about the central bank's desired financial conditions across different scenarios. This uncertainty amplifies the impact of financial noise on financial conditions and generates output gaps. We show that scenario-based FCI communication—announcing the central bank's desired financial conditions under alternative near-term scenarios—mitigates policy uncertainty, recruits arbitrageurs, and stabilizes output gaps. Unconditional FCI forecasts are less effective, as they leave the central bank's reaction function under alternative scenarios opaque. Communicating expected interest rates is less effective still: the mapping from rates to financial conditions is incomplete, so rate projections leave policy intentions "lost in translation."JEL Classifications
- E3 - Prices, Business Fluctuations, and Cycles
- E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit