The Economics of the Fed Put

Abstract

Since mid-1990s, negative stock returns comove with downgrades to the Fed's growth expectations and predict policy accommodations. Textual analysis of FOMC documents reveals that policymakers pay attention to the stock market. The primary mechanism is policymakers’ concern with the consumption-wealth effect, with a secondary role for the market viewed as a predictor of the economy. We find little evidence of the Fed overreacting to the market in an ex-post sense (reacting beyond the market's effect on growth expectations). Although policymakers are aware that the Fed put could induce risk-taking, moral-hazard considerations do not appear to significantly affect their decision-making ex-ante.

Keywords: Fed Put, Monetary Policy, Stock Market, Textual Analysis, Taylor Rules

JEL Classification: E52, G12