Published and Working Papers
Lu, Yundi, and Victor J. Valcarcel. "A Tale of Two Tightenings" Journal of Economic Dynamics and Control 166 (2024): 104906.
A tale of two tightenings - ScienceDirect
Abstract: Balance sheet policy is now a prominent facet of monetary policy. Based on the U.S. experience between 2017 and 2019, Smith and Valcarcel (2023) show the first period of quantitative tightening (QT1) was markedly different from earlier balance sheet expansions. This paper provides evidence the Federal Reserve's second balance sheet unwind effort that began in January 2022 (QT2) is strikingly different from QT1. We find substantial announcement effects during QT2 for various treasury yields and interest rate spreads, which are largely absent from QT1. At the time of this writing—by February 2023—both episodes have experienced a similar percent reduction in reserve balances. Yet, QT2 shows a stronger market response upon implementation. Not only are the underlying financial conditions different across the two periods, but the conduct of monetary policy in 2022 seems to be different as well. A clearer signaling mechanism for the expectations channel of monetary transmission takes place during QT2 than was apparent during QT1. The liquidity effects that seemed to be so important during QT1 have been largely attenuated during the second episode of balance sheet tightening.
Lu, Yundi. "The Financial Market Effects of Inflation Expectations Shock in the Post-pandemic Era" Working Paper
Abstract: Current studies have made it clear that disruptions in supply chains and expansionary fiscal responses related to Covid-19 have all contributed to exacerbated real inflation and inflation expectations since 2021. The impact of inflation expectation dynamics, especially on financial markets, is less well understood. This paper provides an analysis of the financial market effects of widening spreads between short-term and long-term inflation expectations based on U.S. data between 2020 and 2023. We find evidence that spiking inflation expectation spreads significantly tighten narrow and broad financial conditions. In particular, we find that supply chain disruptions and subsequent Treasury General Account (TGA) balance increases enlarge the gap between 1-year and 10-year inflation expectations, but they have different effects on financial markets. We find the Treasury bond yields, corporate bond yields and equity returns respond slightly to supply chain constraints. Conversely, expansionary fiscal policies tighten financial conditions broadly and narrowly during the Covid-19 pandemic. These findings suggest the potential dilemma the Fed is facing to fulfill its price stability mandate while maintaining financial stability.