DP12275 Monetary Policy and Asset Valuation

Author(s): Francesco Bianchi, Martin Lettau, Sydney C. Ludvigson
Publication Date: September 2017
Date Revised: April 2021
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

We document large, longer-term, joint regime shifts in asset valuations and the real federal funds rate-r^{â??} spread. To interpret these findings, we estimate a novel macro-finance model of monetary transmission and find that the documented regimes coincide with shifts in the parameters of a policy rule, with long-term consequences for the real interest rate. Estimates imply that two-thirds of the decline in the real interest rate since the early 1980s is attributable to regime changes in monetary policy. The model explains how infrequent changes in the monetary policy stance can generate persistent changes in asset valuations and the equity premium.