Working Paper: NBER ID: w22572
Authors: Francesco Bianchi; Martin Lettau; Sydney C. Ludvigson
Abstract: We document large, longer-term, joint regime shifts in asset valuations and the real federal funds rate-r* 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.
Keywords: Monetary Policy; Asset Valuation; Equity Premium
JEL Codes: E02; E4; E52; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| regime shifts in monetary policy (E63) | asset valuations (G32) |
| regime shifts in monetary policy (E63) | real interest rate (E43) |
| transition from hawkish to dovish monetary policy regimes (E63) | higher asset valuations (G19) |
| persistent low MPS regimes (E63) | high asset valuations (G19) |
| high MPS regimes (E65) | lower asset valuations (G19) |