FCI-star

Central banks rely on r∗—the neutral interest rate—to assess policy stance. However, monetary policy affects activity through broad financial conditions, not only the short-term rate. We propose FCI∗, the neutral level of a financial conditions index consistent with output at potential. Unlike r∗, FCI∗ is insulated from financial fluctuations: when asset prices move, FCI captures their estimated effect on output, leaving FCI∗ to reflect only what the macroeconomy requires. In U.S. data, r∗ co-moves with the equity premium; FCI∗ does not. FCI gaps provide useful real-time guidance on policy stance, especially when financial conditions diverge from the policy rate.