The Economics of the Fed Put
70 Pages Posted: 14 Apr 2017 Last revised: 23 Mar 2019
Date Written: September 1, 2018
We document that since the mid-1990s low stock market returns predict accommodating policy by the Federal Reserve. We show that this fact emerges because, over this period, (i) negative stock returns are strongly correlated with downgrades to the Fed's growth expectations, and (ii) growth downgrades are highly significant in a Taylor rule framework. We use textual analysis of FOMC minutes and transcripts to argue for a causal effect of the stock market on the Fed's growth expectations and thereby on policy. We document that FOMC members pay attention directly to the stock market and view it as a causal factor for the economy. The primary mechanism, as perceived by the Fed, is the effect of the stock market on consumption (and to some extent investment); less attention is focused on the stock market simply predicting (as opposed to driving) the economy. The Fed's expectations updating is roughly in line with that of private sector forecasters and with the stock market's predictive power for realized growth and unemployment.
Keywords: Fed Put, Monetary Policy, Stock Market, Textual Analysis, Taylor Rules
JEL Classification: E52, G12
Suggested Citation: Suggested Citation