Monetary Policy and Asset Valuation

Francesco Bianchi; Martin Lettau; Sydney C. Ludvigson

doi:10.3386/w22572

Monetary Policy and Asset Valuation

Francesco Bianchi, Martin Lettau & Sydney C. Ludvigson

Working Paper 22572

DOI 10.3386/w22572

Issue Date August 2016

Revision Date January 2021

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.

We thank Ian Dew-Becker, Emmanuel Farhi, Simon Gilchrist, Matteo Maggiori, Emi Nakamura, Monika Piazzesi, Jon Steinsson, Andrea Tamoni, Harald Uhlig, and Michael Weber for helpful comments and seminar participants at the Bundesbank, Columbia, HEC Montreal, NYU, UCL, UCLA, the University of Texas at Austin, Minneapolis Fed, Indiana University, Carey–Johns Hopkins University, the National Bank of Belgium, Booth–University of Chicago, the Workshop on Monetary Policy, NY Fed, April 2017; the Financial Markets and Macroeconomic Performance conference, Frankfurt, May 2017; the Developments in Empirical Monetary economics Conference, FRB May 2017; the SED June 2017; the CCBS Research Forum on Macrofinance, Bank of England June 2017, the Barcelona GSE Summer Symposium, June 2017; the Computing in Economics and Finance conference, June 2017, Wolfe Research’s Global Quantitative and Macro Investment Conference, November 2017, and the 2018 American Economic Association meetings. We thank Paulo Manoel for excellent research assistance. Any errors or omissions are the responsibility of the authors. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
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