State-dependent monetary policy transmission and financial market tensions

- Is monetary policy more powerful when strains in the financial system are high?
- I approach this question by applying local projections to US time series.
- I allow monetary policy shocks and its propagation to the economy to be time-varying.
- As state indicator, I proxy financial market tensions with the excess bond premium.
- I find stronger and more persistent effects of monetary policy in high tension states.

Is monetary policy more powerful when strains in the financial system are high? Applying local projections to US time series, I approach this question by allowing monetary policy shocks and its propagation to the broader economy to smoothly vary according to a measure of financial market tensions-the so-called excess bond premium (EBP). I find that monetary policy impacts macroeconomic, housing, and financial variables stronger and more persistently when financial frictions are high.