Monetary Policy and Asset Valuation

Abstract

We document large, longer term, joint regime shifts in asset valuations and the real federal funds rate- (Formula presented.) spread. To interpret these findings, we estimate a novel macrofinance 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 stance of monetary policy can generate persistent changes in asset valuations and the equity premium.