Despite a significant expansion in central bank balance sheets, some markets like the US money market have experienced increasing interest rate volatility, including significant spikes in the repo rate, notably in September 2019 (see Copeland, Duffie and Yang (2021), Correa, Du, and Liao (2021), D’Avernas and Vanderweyer (2021), and Yang (2021)). This apparent disruption in money markets that depend intimately on the availability of liquidity seems puzzling when the cash and central bank reserves held by the US private sector at the end of 2019 were around 4 times their holdings before the Global Financial Crisis in 2007. Greater liquid holdings do not seem to have made markets for liquidity more immune to liquidity shocks. Indeed, markets were disrupted yet again in March 2020 at the onset of the COVID-19 pandemic and the banking system was found short in its ability to accommodate the demand for liquidity. In response, the Federal Reserve expanded its balance sheet yet more (see, for example, Kovner and Martin (2020)), buying financial assets from the private sector and placing large quantities of liquid reserves with it (or promising to do so). Where had all the prior liquidity gone?

In recent years, and especially in the wake of the Great Recession of 2008-09, the Federal Reserve has paid increasing attention to employment data that go beyond the broad unemployment rate. For example, a low aggregate unemployment rate may mask higher rates for groups that, on average, are not as firmly attached to the labor market, like women, Blacks, and the least educated.

In recent decades, and especially since the Great Recession, interest rates have remained very low, meaning that central banks have had to devise new ways to invigorate the economy in times of recession. In some cases, like quantitative easing, whereby central banks purchase long-term securities in the open market to increase the money supply and encourage lending and investment, these new tools are deemed unconventional.

Policymakers make economic policies based, in part, on their assumptions about how households and businesses will react to a given change in policy. This is especially true of monetary policy, where central banks work to set interest rates that both encourage or discourage economic activity, while keeping inflation at bay.

In the aftermath of the Financial Crisis (2007-08) and the Great Recession (2007-09), households and firms faced lots of uncertainty, not only about when and how the economy would recover, but also confusion on whether and how the administration, Congress, and the Federal Reserve would react. For families considering the purchase of a new car or a move to another city for a job, and for businesses considering new hires or a plant expansion, this policy uncertainty meant that the prudent choice was often wait-and-see.

In the months and years following the Financial Crisis and Great Recession of 2007-09, the Federal Reserve and the European Central Bank engaged in a number of unconventional policy measures meant to forestall a further drop in economic activity and, ultimately, to ignite economic growth. One of those measures, forward guidance, was intended to stimulate current consumption by informing the public that interest rates would be kept inordinately low for an extended period and hence increasing their inflation expectations.