DP12275 Monetary Policy and Asset Valuation

Author(s): Francesco Bianchi, Martin Lettau, Sydney Ludvigson
Publication Date: September 2017
Date Revised: June 2018
Keyword(s): Asset Pricing, monetary policy, Real interest rate, Risk premium
JEL(s): G10, G12, G17
Programme Areas: Financial Economics, Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=12275

This paper presents evidence of infrequent shifts, or "regimes," in the mean of the consumption-wealth variable cayt that are strongly associated with low frequency fluctuations in the real 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 economic growth or lower economic uncertainty; indeed the opposite is true. Additional evidence shows that low interest rate/high asset valuation regimes coincide with significantly lower equity market risk premia.