Learning about the Interdependence between the Macroeconomy and the Stock Market

Fabio Milani

No 70819, Working Papers from University of California-Irvine, Department of Economics

Abstract: How strong is the interdependence between the macroeconomy and the stock market? This paper estimates a New Keynesian general equilibrium model, which includes a wealth effect from asset price fluctuations to consumption, to assess the quantitative importance of interactions among the stock market, macroeconomic variables, and monetary policy. The paper relaxes the assumption of rational expectations and assumes that economic agents learn over time and form near-rational expectations from their perceived model of the economy. The stock market, therefore, affects the economy through two channels: through a traditional ``wealth effect" and through its impact on agents' expectations. Monetary policy decisions also affect and are potentially affected by the stock market. The empirical results show that the direct wealth effect is modest, but asset price fluctuations have had important effects on output expectations. Shocks in the stock market can account for a large portion of output fluctuations. The effect on expectations, however, has declined over time.

Keywords: Stock market; Wealth channel; Monetary policy; Constant-gain learning; Bayesian estimation; Expectations (search for similar items in EconPapers)
JEL-codes: E32 E44 E52 E58 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2008-05
New Economics Papers: this item is included in nep-cba, nep-mac and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (25)

Downloads: (external link)
https://www.economics.uci.edu/files/docs/workingpapers/2007-08/milani-19.pdf (application/pdf)

Related works:
Journal Article: Learning about the interdependence between the macroeconomy and the stock market (2017)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:irv:wpaper:070819

Access Statistics for this paper

More papers in Working Papers from University of California-Irvine, Department of Economics Contact information at EDIRC.
Bibliographic data for series maintained by Melissa Valdez ().