Working Paper: CEPR ID: DP12671
Authors: Martin Lettau; Sydney Ludvigson; Francesco Bianchi
Abstract: We find evidence of infrequent shifts, or "regimes" in the mean of the asset valuation variable cayt that are strongly associated with low-frequency fluctuations in the real federal funds rate, with low policy rates associated with high asset valuations, and vice versa. There is no evidence that infrequent shifts to high asset valuations are associated with higher expected economic growth or lower economic uncertainty; indeed, the opposite is true. Additional evidence shows that regimes of low interest rates and high asset valuations are characterized by lower equity market risk premia and monetary policy that is less responsive to inflation.
Keywords: Monetary policy; Asset valuation; Risk premia
JEL Codes: G10; G12; G17
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| infrequent shifts in the consumption-wealth variable (CAY) (E21) | low-frequency fluctuations in the real federal funds rate (E39) |
| low-frequency fluctuations in the real federal funds rate (E39) | asset valuations (G32) |
| low asset valuation regimes (G32) | high expected values for the real federal funds rate (E43) |
| high asset valuation regimes (G32) | low expected values for the real federal funds rate (E43) |
| high asset valuation regimes (G32) | lower growth and higher economic uncertainty (O49) |
| low interest rates and high asset valuations (G19) | decline in equity market risk premia (G12) |
| high asset valuation regimes (G32) | diminished responsiveness of monetary policy to inflation (E31) |
| high asset valuation regimes (G32) | change in central bank's focus towards output stabilization (E63) |