Monetary Policy and Asset Valuation

• DOI: 10.1111/jofi.13107
• Publication Date: 2022-01-19T08:09:18Z
• Authors: FRANCESCO BIANCHI; MARTIN LETTAU; SYDNEY C. LUDVIGSON
• Keywords: Real interest rate; Asset Pricing; Risk premium; 8. Economic growth; 0502 economics and business; 05 social sciences; monetary policy

ABSTRACTWe document large, longer term, joint regime shifts in asset valuations and the real federal funds rate‐ spread. To interpret these findings, we estimate a novel macrofinance 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 stance of monetary policy can generate persistent changes in asset valuations and the equity premium.