Board of Governors of the Federal Reserve System

Abstract:

We provide evidence that banks use loan covenants to prepare for future monetary policy tightening, thereby facilitating the bank lending channel of monetary policy transmission. Specifically, banks with greater monetary policy exposure—those whose lending capacity contracts more as the federal funds rate increases—include stricter financial covenants in loan contracts, granting them flexibility to reduce existing loan commitments during monetary policy tightening when firms breach covenants. The resulting credit reductions to covenant violators by high-exposure banks account for over one-third of the total decline in credit during recent federal funds rate hikes.

Keywords: Loan contracting, Covenant strictness, Covenant violations, Monetary policy exposure, Monetary policy transmission, Bank lending channel

DOI: https://doi.org/10.17016/FEDS.2026.008

Abstract:

We create an annualized measure of comprehensive household wealth using the 1998–2022 waves of the Health and Retirement Study and examine heterogeneity in retirement resources across households, cohorts, and time. We augment traditional net worth with the actuarial present values of expected future payment streams from labor-market earnings, Social Security, defined-benefit pensions, annuities, life insurance, and government transfers. We then calculate an annualized measure of that lump sum by converting it into an actuarially fair joint life annuity that we call annualized comprehensive wealth (ACW). We find that the median ACW increases throughout retirement, indicating that the median household is spending down its total resources more slowly than its joint life expectancy is shortening. In addition, we document considerable heterogeneity in the levels and trajectories of ACW across cohorts, education groups, and race. Notably, we find that the pattern of rising ACW is largely driven by college-educated and White households. Other groups show relatively flat or declining trajectories of ACW after retirement. We further explore the heterogeneity of ACW with the help of recentered influence function regressions. We show that inequality in ACW is associated with higher household-specific rates of return, higher education, and greater concentrations of single-headed and Black and Hispanic households.

Keywords: Saving, wealth accumulation, cohort effects, retirement, inequality

DOI: https://doi.org/10.17016/FEDS.2026.007

Abstract:

Large language models (LLMs) are now used for economic reasoning, but their implicit "preferences" are poorly understood. We study these preferences by analyzing revealed choices in canonical allocation games and a sequential job-search environment. In dictator-style allocation games, most models favor equal splits, consistent with inequality aversion. Structural estimation of Fehr-Schmidt parameters suggests this aversion exceeds levels typically observed in human experiments. However, LLM preferences prove malleable. Interventions such as prompt framing (e.g., masking social context) and control vectors reliably shift models toward more payoff-maximizing behavior, while persona-based prompting has more limited impact. We then extend our analysis to a sequential decision-making environment based on the McCall job search model. Here, we recover implied discount factors from accept/reject behavior, but find that responses are less consistently rationalizable and preferences more fragile. Our findings highlight two core insights: (i) LLMs exhibit structured, latent preferences that often align with human behavioral norms, and (ii) these preferences can be steered, albeit more effectively in simple settings than in complex, dynamic ones.

Keywords: Large language models, McCall search, intertemporal choice, rational expectations, revealed preferences, social preferences, structural estimation

DOI: https://doi.org/10.17016/FEDS.2026.006

Abstract:

We study the spillovers of large-scale asset purchases (LSAPs) in the U.S. on financial intermediation in the euro area using bank-level supervisory data and high-frequency identified policy surprises. Our detailed panel data permit us to trace the impact of LSAPs through bank balance sheets. We find that the Federal Reserve affects credit provision in the euro area through a channel that we refer to as the "international bank capital channel'' of unconventional monetary policy. In response to an LSAP shock that leads to a steepening of the U.S. Treasury yield curve, the Treasury positions of euro area banks shrink, capital ratios worsen, and banks that are less well capitalized contract their lending relative to banks that are better capitalized. Our results are consistent with an important role of revaluation effects, imperfect risk hedging, and credit as an adjustment margin for banks in the proximity of regulatory capital constraints.

Keywords: Large-Scale Asset Purchases, International Spillovers, Global Financial Cycle, Credit Channel of Monetary Policy, U.S. Treasury Yield Curve, Exchange Rates

DOI: https://doi.org/10.17016/FEDS.2026.005

Abstract:

We apply various natural language processing tools to see if the Beige Book is helpful in understanding economic activity. The Beige Book is a gathering of anecdotal compilations of current economic conditions from each Federal Reserve Bank, which is released to the public prior to FOMC meetings. We find that even controlling for lagged GDP growth and other metrics, the Beige Book sentiment provides meaningful explanatory power in nowcasting GDP growth and forecasting recessions, even more so than the yield spread or other news sentiment measures. The results on economic activity even hold in regional panel analysis. The Beige Book offers many more insights on the economy that can be gathered from even simple keyword tabulations. Topic modeling can also inform us about the different factors driving the narrative across particular periods of interest.

Keywords: Beige Book, real economic activity, recessions, nowcasting and forecasting, FinBERT, machine learning, sentiment analysis, natural language processing

DOI: https://doi.org/10.17016/FEDS.2026.004

Abstract:

I study how fluctuations in business formation and destruction affect inflation and the transmission of monetary policy. To do this analysis, I extend a New Keynesian model to include endogenous business formation and destruction and heterogeneous producers. A decline in the number of producers puts upward pressure on inflation, and I find that this mechanism can explain about half of the missing deflation following the Great Recession. I then study the transmission of monetary policy in this framework. I show that endogenous fluctuations in entry generate an intertemporal trade-off in monetary policy; a contractionary shock leads employment and inflation to decline on impact, but inflation later overshoots, as the shock also causes a decline in entry and an increase in exit.

DOI: https://doi.org/10.17016/FEDS.2026.003

Abstract:

New money-like products, such as tokenized money market funds (MMFs), money market exchange-traded funds (MMETFs), and stablecoins, could be transformative for finance. These products may offer significant benefits, but like other money-like assets, they also have certain vulnerabilities. We introduce a framework to analyze the vulnerabilities of new products by comparing their features to those that contribute to vulnerabilities in MMFs. Specifically, we examine the extent to which each product engages in liquidity transformation, is subject to threshold effects, serves as a money-like asset, poses contagion risks, and has reactive investors. Our framework is useful for assessing the potential effects of novel cash-like products on the overall resilience of the financial system and how such an assessment may change as these products’ uses evolve.

Keywords: money market funds (MMFs), stablecoins, tokenized money market funds, money market exchange-traded funds (MMETFs), financial stability, liquidity transformation, private money-like assets, moneyness, contagion, reactive investors, thresholds

DOI: https://doi.org/10.17016/FEDS.2026.002

Abstract:

The 2021-2022 inflation episode presented the first opportunity to examine inflation and price dispersion using U.S. scanner data in a high-inflation environment. Data from 50,000 outlets reveals that price changes across similar goods grew more dispersed in 2022 before falling again in 2023. This paper documents how price change dispersion interacts with households' product choices to generate substantial inflation heterogeneity. Household-level inflation rates exhibit a 1.4 percentage point interquartile range in 2019, which grew to 4.0 percentage points in 2022 before falling back to 1.6 percentage points in 2023. Households offset little of their implied budget shocks through substitution. A model with idiosyncratic preferences rationalizes household behavior and implies that households' inflation rates represent convenient, observable bounds on their welfare losses. When inflation peaked in 2022, households at the 10th and 90th percentiles of the inflation distribution and average grocery expenditures faced welfare losses of $573 and $1,145, respectively.

DOI: https://doi.org/10.17016/FEDS.2026.001