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Abstract

In this article, we summarize empirical research on the interaction between monetary policy and asset markets and review our previous theoretical work that captures these interactions. We present a concise model in which monetary policy impacts the aggregate asset price, which in turn influences economic activity with lags. In this context, the following occurs: () the central bank (the Fed, for short) stabilizes the aggregate asset price in response to financial shocks, using large-scale asset purchases if needed (the Fed put); () when the Fed is constrained, negative financial shocks cause demand recessions; () the Fed's response to aggregate demand shocks increases asset price volatility, but this volatility plays a useful macroeconomic stabilization role; () the Fed's beliefs about the future aggregate demand and supply drive the aggregate asset price; () macroeconomic news influences the Fed's beliefs and asset prices; () more precise news reduces output volatility but heightens asset market volatility; and () disagreements between the market and the Fed provide a microfoundation for monetary policy shocks and generate a policy risk premium.

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2024-11-01
2025-02-11
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