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Monetary Policy, Financial Conditions and the Economy

Paper Session

Friday, Jan. 5, 2018 10:15 AM - 12:15 PM

Marriott Philadelphia Downtown, Grand Ballroom Salon B
Hosted By: American Economic Association
  • Chair: Annette Vissing-Jorgensen, University of California-Berkeley

Monetary Policy and Asset Valuation

Francesco Bianchi
,
Duke University
Martin Lettau
,
University of California-Berkeley
Sydney Ludvigson
,
New York University

Abstract

This paper presents evidence of infrequent shifts, or “breaks,” in the mean of the consumption-wealth variable cay_t that are strongly associated with fluctuations in the long-run expected value of the Federal Reserve's primary policy rate, with low policy rates associated with high asset valuations, and vice versa. By contrast, there is no evidence that infrequent shifts to high asset valuations and low policy rates are associated with higher expected economic growth or lower economic uncertainty; indeed the opposite is true. Additional evidence supports a “reaching for yield” channel, wherein low interest rate regimes coincide with low equity market risk premia.

The Economics of the Fed Put

Anna Cieslak
,
Duke University
Annette Vissing-Jorgensen
,
University of California-Berkeley

Abstract

We study the impact of the stock market on the Federal Reserve’s monetary policy. We analyze the economics behind the “Fed put,” i.e., the tendency for low stock returns to predict accommodating monetary policy. We show that stock returns are a statistically more powerful predictor of Federal funds target changes than standard macroeconomic news releases. Using textual analysis of FOMC minutes and transcripts, we then argue that stock returns cause Fed policy. FOMC participants are more likely to be concerned about the stock market after market declines and the frequency of negative stock market mentions in FOMC documents predicts target rate cuts. The focus on the stock market reflects Fed’s concern about the consumption-wealth effect and about the impact of the stock market on investment, with less role for the stock market simply predicting (as opposed to driving) the economy. We assess whether the Fed may be reacting too much to the stock market by (a) comparing the sensitivity to the stock market of the Fed’s growth, unemployment and inflation forecasts with the stock-market sensitivity of private sector forecasts, and (b) estimating whether the stock market impacts target changes even after controlling for Fed expectations of economic activity and inflation.

Feedbacks: Financial Market and Economic Activity

Markus K. Brunnermeier
,
Princeton University
Darius Palia
,
Rutgers University
Karthik A. Sastry
,
Massachusetts Institute of Technology
Christopher A. Sims
,
Princeton University

Abstract

We examine the relation among measures of credit expansion, measures of financial market stress, and standard macroeconomic aggregates. We use a structural model that is ”lightly” identified — a form of structural VAR — and that uses monthly data on up to 10 variables. The model explains observed variation as driven by 10 mutually independent structural disturbances, one of which emerges as representing monetary policy. There is more than one financial stress shock, suggesting that attempts to create a one-dimensional index of financial stress may be misguided. In pseudo-out-of-sample forecasting tests, neither bond spreads, interbank spreads, nor credit aggregates had much predictive value far in advance of the 2008-9 downturn, though spreads (but not credit aggregates) were helpful in recognizing the downturn once it had begun. No strong pattern of credit expansion preceding output declines emerges. Some of these results are in apparent conflict with previous empirical work in this area, and we show that our model can explain the previous results.
Discussant(s)
Ian Dew-Becker
,
Northwestern University
Narayana Kocherlakota
,
University of Rochester
Yuriy Gorodnichenko
,
University of California-Berkeley
JEL Classifications
  • E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit
  • G1 - General Financial Markets