Monetary Policy, Velocity, and the Equity Premium

López-Salido, J David and Christopher Gust
Authors registered in the RePEc Author Service: J. David Lopez-Salido

No 7388, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We develop a DSGE model in which monetary policy generates endogenous movements in risk. The key feature of our model is that households rebalance their financial portfolio allocations infrequently, as they face a fixed cost of transferring cash across accounts. We show that the model can account for the mean returns on equity and the risk-free rate,and generates countercyclical movements in the equity premium that help explain the response of stock prices to monetary shocks. While stimulative monetary policy can lower risk in equity markets, it is also associated with higher inflation expectations and inflation risk premia. The model gives rise to periods in which the zero lower bound constraint on the nominal interest rate binds and demand for liquidity jumps, leading to procyclical movements in velocity.

Keywords: Equity premium; Monetary policy; Velocity (search for similar items in EconPapers)
JEL-codes: E44 E52 (search for similar items in EconPapers)
Date: 2009-08
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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