The Economics of the Fed Put

67 Pages Posted: 14 Apr 2017  

Anna Cieslak

Duke University, Fuqua School of Business

Annette Vissing-Jorgensen

National Bureau of Economic Research (NBER); University of California Berkeley, Haas School of Business

Date Written: April 11, 2017

Abstract

We study the impact of the stock market on the Federal Reserve’s monetary policy. We analyze the economics behind the “Fed put,” i.e., the tendency for low stock returns to predict accommodating monetary policy. We show that stock returns are a statistically more powerful predictor of Federal funds target changes than standard macroeconomic news releases. Using textual analysis of FOMC minutes and transcripts, we then argue that stock returns cause Fed policy. FOMC participants are more likely to be concerned about the stock market after market declines and the frequency of negative stock market mentions in FOMC documents predicts target rate cuts. The focus on the stock market reflects Fed’s concern about the consumption-wealth effect and about the impact of the stock market on investment, with less role for the stock market simply predicting (as opposed to driving) the economy. We assess whether the Fed may be reacting too much to the stock market by (a) comparing the sensitivity to the stock market of the Fed’s growth, unemployment and inflation forecasts with the stock-market sensitivity of private sector forecasts, and (b) estimating whether the stock market impacts target changes even after controlling for Fed expectations of economic activity and inflation.

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

JEL Classification: E52, G12

Suggested Citation

Cieslak, Anna and Vissing-Jorgensen, Annette, The Economics of the Fed Put (April 11, 2017). Available at SSRN: https://ssrn.com/abstract=2951402

Anna Cieslak (Contact Author)

Duke University, Fuqua School of Business ( email )

100 Fuqua Drive
Durham, NC 27708-0204
United States
919 660 7879 (Phone)

HOME PAGE: http://https://sites.google.com/site/ancieslak/

Annette Vissing-Jorgensen

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

University of California Berkeley, Haas School of Business ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States

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