Pride Goes Before a Fall: Federal Reserve Policy and Asset Markets

17 Pages Posted: 28 Feb 2011  

Carmen M. Reinhart

Peter G. Peterson Institute for International Economics; National Bureau of Economic Research (NBER)

Vincent R. Reinhart

American Enterprise Institute (AEI)

Date Written: February 2011

Abstract

Considerable debate rages about whether Federal Reserve policy was too lax in the early part of the 2000s, thereby fueling the home-price bubble that was the proximate cause of the global financial crisis. We present evidence that the view that modest alterations to monetary policy have vast consequences is inconsistent with theory and not supported by evidence. We take a close look at the responses of asset markets to changes in the short-term policy interest rate since the founding of the Fed in 1914. Changes in the federal funds rate have no systematic effect on either long-term interest rates or housing prices over nearly a century. Indeed, since the mid-1990s the policy rate had a negative relationship with long-term interest rates. This is consistent with a global view of capital markets where massive cross-border flows shape the availability of domestic credit and asset prices. The evidence casts doubts on arguments that a moderately different monetary policy path might have mattered.

Suggested Citation

Reinhart, Carmen M. and Reinhart, Vincent R., Pride Goes Before a Fall: Federal Reserve Policy and Asset Markets (February 2011). NBER Working Paper No. w16815. Available at SSRN: https://ssrn.com/abstract=1770370

Carmen M. Reinhart (Contact Author)

Peter G. Peterson Institute for International Economics ( email )

1750 Massachusetts Avenue, NW
Washington, DC 20036
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Vincent R. Reinhart

American Enterprise Institute (AEI) ( email )

1150 17th Street, N.W.
Washington, DC 20036
United States

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