Non-technical summary

Research Question

In this paper, we examine the impact of discussions on financial stability on monetary policy decisions by the Federal Open Market Committee (FOMC). We analyze how the FOMC considers aspects of financial stability in its deliberations and how the relationship between the dual mandate objectives – price stability and maximum employment – and financial stability can be discerned when making decisions on interest rates and balance sheet policies. We also examine whether financial stability considerations and discussions affect the sentiment of the Fed’s monetary policy communication.

Contribution

Based on the FOMC meeting minutes, we examine the influence of the shares of discussion devoted to mandate objectives and financial stability issues on the determination of the Federal Funds Rate, considering differences in the Fed’s behavior during and outside the zero lower bound (ZLB) period. We analyze the discussions using modern methods from the field of natural language processing. Additionally, we employ Explainable AI to understand the results of our AI-based sentiment analysis. Building on this, we develop a new dictionary that can replicate the results of the language model. Finally, to train the language model, we manually create a labeled dataset that classifies FOMC discussions.

Results

The results show that the goals of the dual mandate in the FOMC's discussions, in addition to the Federal Funds Rate, also influence communication after the meeting. A more optimistic discussion during the meeting leads to more positive communication with the public. During the zero lower bound period, discussions about financial stability influence the implementation of unconventional monetary policy and can lead to a more restrictive stance. Since the international financial crisis, financial stability has played an increasingly important role in the FOMC's deliberations.