The Financial Instability – Monetary Policy Nexus: Evidence from the FOMC Minutes

We analyze how financial stability concerns discussed during Federal Open Market Committee (FOMC) meetings influence the Federal Reserve’s monetary policy implementation and communication. Utilizing large language models (LLMs) to analyze FOMC minutes from 1993 to 2022, we measure both mandate-related and financial stability-related sentiment within a unified framework, enabling a nuanced examination of potential links between these two objectives. Our results indicate an increase in financial stability concerns following the Great Financial Crisis, particularly during periods of monetary tightening and the COVID-19 pandemic. Outside the zero lower bound (ZLB), heightened financial stability concerns are associated with a reduction in the federal funds rate, while within the ZLB, they correlate with a tightening of unconventional measures. Methodologically, we introduce a novel labeled dataset that supports a contextualized LLM interpretation of FOMC documents and apply explainable AI techniques to elucidate the model’s reasoning.