Monetary Policy and Asset Valuation
Working Paper 22572
DOI 10.3386/w22572
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We document large, longer-term regime shifts in asset valuations that coincide with shifts in the real federal funds rate and in equity market return premia. To interpret these facts, we specify and estimate a novel macro-finance model of monetary transmission and find that the documented regime shifts coincide with significant shifts in the parameters of a policy rule, with long-lasting consequences for the real interest rate. Our estimates imply that two-thirds of the decline in real interest rates since the early 1980s is attributable to regime changes in monetary policy. The model explains why infrequent changes in the conduct of monetary policy can generate persistent changes in asset valuations and equity return premia.