Central Banks, Stock Markets, and the Real Economy

Ricardo Caballero () and Alp Simsek

No 18653, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: This article summarizes empirical research on the interaction between monetary policy and asset markets, and reviews 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: (i) 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"); (ii) when the Fed is constrained, negative financial shocks cause demand recessions, (iii) the Fed's response to aggregate demand shocks increases asset price volatility, but this volatility plays a useful macroeconomic stabilization role; (iv) the Fed's beliefs about the future aggregate demand and supply drive the aggregate asset price; (v) macroeconomic news influences the Fed's beliefs and asset prices; (vi) more precise news reduces output volatility but heightens asset market volatility; (vii) disagreements between the market and the Fed microfound monetary policy shocks, and generate a policy risk premium.

Keywords: Monetary policy; risk premium (search for similar items in EconPapers)
JEL-codes: E43 E44 E52 G12 (search for similar items in EconPapers)
Date: 2023-12
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Working Paper: Central Banks, Stock Markets, and the Real Economy (2024)
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