Which levels of interest rates along the yield curve are consistent with stable economic activity? We use expectations at the daily frequency reflected in financial market prices to extract the state of the economy within a textbook New Keynesian model. We use these real-time estimates to derive neutral and optimal monetary policy rates at each horizon. The model identifies perceived demand and supply shocks on each day, along with their persistence and associated risk premiums. We find that financial markets started to predict the post-COVID surge in inflation by mid-2021 and inflation risk premiums turned positive soon thereafter. The resulting inflation forecasts from the model are at least as accurate as several leading alternatives.

We express the aggregate budget constraint of the economy as nesting the budget constraints of the private, public, and external sectors (e.g., equities, Treasuries, and foreign assets). This formulation implies that valuation ratios in one sector may capture fluctuations in future real returns and cash-flow growth in other sectors. Exploiting the cross-sector restrictions implied by the aggregate constraint, we show that fluctuations in the government surplus-to-debt ratio robustly predict equity returns. The magnitude of this cross-sector predictability is on par with the own-sector predictability associated with the dividend–price ratio. We then develop a model in which distortionary taxes generate these time-series dynamics and use the cross-sector forecasts to calibrate the implied magnitude of the tax distortions.v

We propose a channel whereby uncertainty about the central bank's reaction function raises risk premia, especially when inflation deviates from target. To test the channel, we focus on the period after the Federal Reserve's revision of its policy framework in 2020. Post-framework communication introduced reaction function uncertainty just as inflation surged to a four-decade high. Market concerns about policy mistakes amid incoming data drove up term premia, undermining the easy financial conditions the Fed initially sought. While short-rate expectations were anchored by forward guidance, term premium sensitivity to inflation news increased. The subsequent shift in the Fed's words and then actions, reaffirming its anti-inflation stance, stabilized premia and neutralized the effect of macroeconomic news on long-term yields.