Fed's Balance Sheet Plays Key Role in Shaping Financial Conditions
The Federal Reserve Bank of Atlanta has released a study examining the relationship between monetary policy and financial conditions in the US. The researchers found that, despite the central bank's hiking cycle starting in March 2022, financial conditions had actually tightened before the Fed began raising interest rates.
In fact, the Financial Conditions Impulse on Growth (FCI-G) index, which measures the stance of monetary policy, peaked at the end of 2022 and didn't begin to ease until September 2024. This discrepancy between financial conditions and the policy rate can be attributed to several factors, including a possible increase in the 'neutral' interest rate or external influences on global financial conditions.
The researchers also analyzed the impact of the Fed's balance sheet on financial conditions, finding that changes in liquidity provision have a significant effect on the FCI-G index. Specifically, they found that the aggregate liquidity tightened during 2022 and eased from early 2023 to late 2025, closely aligning with the policy rate path.
To better understand the interplay between monetary policy and financial conditions, the researchers constructed a simple index of monetary policy stance (MPI) combining the policy rate and balance sheet components. The MPI shows that the monetary policy stance has gradually tightened over time, peaking in August 2023 before declining to 0.92 by May 2026.