Working Paper: NBER ID: w26894
Authors: Anna Cieslak; Annette Vissing-Jorgensen
Abstract: Since the mid-1990s, low stock returns predict accommodating policy by the Federal Reserve. This fact emerges because, over this period, negative stock returns comove with downgrades to the Fed’s growth expectations. Textual analysis of the FOMC documents reveals that policymakers pay attention to the stock market, and their negative stock-market mentions predict federal funds rate cuts. The primary mechanism why policymakers find the stock market informative is via its effect on consumption, with a smaller role for the market viewed as predicting the economy.
Keywords: Federal Reserve; stock market; monetary policy
JEL Codes: E44; E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| 5 percent decrease in the stock market (G17) | 14 basis point reduction in the federal funds rate (FFR) target (E52) |
| low stock returns (G17) | accommodating policy by the Federal Reserve (E52) |
| negative stock returns (G12) | federal funds rate cuts (E52) |
| 10 percent decline in stock market returns (G17) | 32 basis point reduction in the FFR target at the next meeting (E52) |
| 10 percent decline in stock market returns (G17) | 127 basis point reduction in the FFR target after one year (E52) |
| stock market performance (G10) | Fed's expectations about real activity (output growth and unemployment) (E39) |
| negative stock returns (G12) | policy easings (E52) |
| stock market behavior (G41) | Federal Reserve policy responses (E52) |