Asset Prices in a Flexible Inflation Targeting Framework

I. INTRODUCTION Over the past decade, the policy statements issued by the Federal Open Market Committee (FOMC) after each meeting have become an increasingly important element of monetary policy-making in the United States. These statements provide about the Fed's view on economic outlook, key forces that are likely to shape future developments and potential implications for monetary policy. Therefore, on policy announcement days, market participants monitor closely not only what the Fed does (interest rate decisions), but also what it says (FOMC statements). One striking example is the policy announcement of January 28, 2004, when the Fed kept its target rate unchanged (a move that was widely anticipated by the market), but unexpectedly altered the wording of the statement, causing one of the largest reactions on record in financial markets. Theoretically, central bank communication should not matter to market participants if the central bank is committed to an unchanged policy rule and the public has a perfect understanding of the rule, the objectives, and the thinking of the monetary authority. In reality, the central bank cannot possibly commit to an inflexible policy rule given that the number of contingent states is infinite (Blinder et al. 2008). Consequently, the public needs to estimate the policy function and because the central bank invariably knows more about its future moves, the dissemination of this is important to market participants. It appears that, at least in practice, market participants should pay attention to the content of FOMC statements. However, more does not always translate to greater clarity and ill-conceived statements confuse rather than enlighten. Kahneman (2003) argues that there are limits to how much can be digested effectively and more may reduce common understanding among market participants. Moreover, central bank communication may be welfare reducing if agents place too much weight on policy statements and too little on their own information, thus crowding-out private beliefs which are an important source of for the Fed (Amato, Morris, and Shin 2002; Morris and Shin 2002). In addition, the Fed may increase noise if it communicates on which it has imprecise knowledge--such as on future economic developments rather than the policy path. This paper contributes to a young but rapidly growing literature on central bank communication by evaluating the impact of the content of FOMC statements on the level and volatility of Treasuries and stock returns. To measure the information content, we assess the consensus view about the importance of the statements by collecting stories from three major sources right after a policy meeting. This allows us to group statements into two broad categories, and uninfor-mative, with informative statements delivering important which was not previously anticipated by the consensus. A priori, we expect asset prices to respond asymmetrically to the type of information, with informative statements generating a larger response. Figure 1 seems to confirm this idea: the chart plots changes in S&P 500 and Treasury yields around policy announcements with solid bars representing dates when the statement was informative. As seen, the largest asset price changes typically occur when a statement releases important information, which indicates that markets do react to the content. One reason for this oversized response is that the delivered by these statements creates news in the sense that the content is both important and unexpected. If the relates to future monetary policy, about which the Fed is expected to possess superior knowledge, then it should have a considerable impact on asset prices. However, statements routinely transmit the Fed's economic outlook which may be interpreted as an additional policy signal because this outlook presumably shapes the future course of monetary actions. …

The financial risks and potential systemic impacts induced by climate change and the transition to a low‐carbon economy have become a central issue for both financial investors and their regulators. In this article, we develop a critical review of the empirical and theoretical literature concerning the impact of climate‐related risks on the price of financial assets. We first present the theoretical links between asset pricing and climate‐related risks and develop a theory of how climate risk drivers transmit costs to firms and lead to asset price changes. We then discuss studies looking at past climate‐related events, which show that both climate physical impacts and transition dynamics can trigger a revaluation of financial assets through multiple direct and indirect channels. Finally, we review the emerging literature that uses forward‐looking methodologies to estimate future climate‐related asset price changes, which suggests that climate financial risks can indeed have significant implications on financial stability.

With goods prices being sticky, monetary impulses are initially transmitted to the real economy via changes in asset prices; and asset price fluctuations can independently affect monetary and real developments. Most empirical models try to incorporate such monetary–asset price interactions by the inclusion of a short‐term interest rate and the exchange rate, but there are good reasons to doubt the sufficiency of this. Here we examine whether the predictive power of a reduced form equation for inflation, including standard explanatory variables, can be improved by adding other asset price variables, i.e. the changes in housing and equity prices and a yield spread. In our cross‐country time series exercise, we find that housing price movements do provide useful extra information on future inflation, with equity prices and the yield spread being somewhat less informative.

Asset price changes play a pivotal role in driving wealth inequality. This paper takes the unexpected interest rate cut by the People’s Bank of China in 2014 as a “policy shock” and uses the Propensity Score Matching-Difference-in-Differences (PSM-DID) method along with the Triple Differences (DDD) model to assess the uneven wealth distribution effects generated by the interest rate reduction through the stock market. The findings indicate that as household participation in the stock market, stock market capitalization share, and stock asset allocation efficiency become increasingly skewed toward the upper echelons of wealth distribution, affluent households reap greater benefits from the stock market upswing, thereby contributing to the widening wealth gap. This paper complements research on the impact of monetary policy on wealth inequality through the asset price channel.

Has Inflation Targeting Improved Monetary Policy? Evaluating Policy Effectiveness in Australia, Canada, and New Zealand

Since the initial launch of inflation targeting in the early 1990s in New Zealand and a few other countries, inflation targeting has become the predominant monetary policy strategy in large advanced and emerging market economies. Inflation targeting has been remarkably successful in anchoring inflation, likely owing to core elements of the framework across central banks. Its reaction process, which adjusts the monetary policy stance to ensure the return of inflation to target, allows it to flexibly incorporate a wide range of factors while limiting the discretionary biases that can contribute to excessive inflation. The emphasis on communications about the inflation outlook promotes transparency and accountability. As a result, inflation targeting central banks have, on balance, managed well the large shocks associated with the Global Financial Crisis and COVID. Even so, there are numerous challenges discussed in this paper that are associated with calibration and communications of forward guidance, quantitative easing/tightening, and financial stability.

3 - The dynamics of asset prices

We investigate financial market correlations using random matrix theory and principal component analysis. We use random matrix theory to demonstrate that correlation matrices of asset price changes contain structure that is incompatible with uncorrelated random price changes. We then identify the principal components of these correlation matrices and demonstrate that a small number of components accounts for a large proportion of the variability of the markets that we consider. We characterize the time-evolving relationships between the different assets by investigating the correlations between the asset price time series and principal components. Using this approach, we uncover notable changes that occurred in financial markets and identify the assets that were significantly affected by these changes. We show in particular that there was an increase in the strength of the relationships between several different markets following the 2007-2008 credit and liquidity crisis.

Movements in the prices of different assets are likely to directly influence one another. This paper develops a model that identifies the contemporaneous interactions between asset prices in U.S. financial markets by relying on the heteroskedasticity in their movements. In particular, we estimate a "structural-form GARCH" model that includes the short-term interest rate, the long-term interest rate, and the stock market. The results indicate that there are strong contemporaneous interactions between these variables. Accounting for this behavior is critical for interpreting daily changes in asset prices and for predicting the future paths of their variances and correlations. We demonstrate the importance of this consideration in a risk-management application.

Quantitative easing represents a variation of trickle-down economics. The presumption is that asset purchases by the Federal Reserve (Fed) benefit everyone. The policy involves increasing the prices of treasury bonds and mortgage-backed assets to stimulate output and employment. Quantitative easing acts on balance sheets. It works through the price system by affecting the structure of prices, and hence wealth. The unemployed, lacking assets, are not directly affected by changes in asset prices. The unemployed are dependent on policies that generate income. While Fed intervention prevented a collapse in asset prices, its effect on the real economy remains tenuous. Data suggests that the policy has exacerbated the inequality in the distribution of wealth and income, has done little to reduce unemployment, and has violated the principles of social justice. The policy contrast sharply with fiscal policy employed during WWII, which promoted greater equality in the distribution of income.

A model representing an asset price change as the sum of several random functions with different correlation properties is proposed. Its adequacy is substantiated and boundaries of its application are described. The random character of deterministic component of asset price set is defined on the basis of empirically established properties of the asset price and the exponential moving average graphs intersection. The function of price changes is presented as a random Markov process. The choice of the model adequacy evaluation method according to this hypothesis is substantiated. The synthesis of nonlinear filter is carried out to separate the deterministic component of the asset price changes function. The results of digital simulation of the synthesized filter algorithm are presented, and conclusion about hypothesis acceptance is made for limited conditions. The main research conclusion looks as follows: in limited time intervals it is possible and expedient to represent the asset price changes function as a sum of several random functions with different correlation properties. In particular, it is proposed to use random Markov process.

Financial crisis in 2007-2008 have caused losses to life insurance companies issuing variable annuities with guarantees. This is partly due to failure of variable annuity (VA) issuers to anticipate the large variations in asset prices during the financial crisis times in their pricing framework and also setting a higher guaranteed rate. This study aims to investigate the pricing of the guaranteed minimum death and accumulation benefits embedded in flexible premium VA. We compare the prices from calibrated Black-Scholes model to that of calibrated jump-diffusion model. Although both models assume constant volatility, the fact that Black-Scholes model ignores abnormal asset price changes due to jumps is likely to under-price the VA. We also conduct a case study to analyse the impact on guarantee fees for different stock market performance and regional mortality rates.

Stocks, Bonds, Money Markets and Exchange Rates: Measuring International Financial Transmission

The Stock Market, Housing and Consumer Spending: A Survey of the Evidence on Wealth Effects

The term wealth in wealth inequality is referred to the total asset of a household, and the wealth inequality implies the uneven distribution of wealth within a community. While many papers have discussed and investigated the change in wealth inequality in the past, this paper aims to investigate the change in wealth inequality during the COVID-19 pandemic (Q4 2019 to Q2 2022) in the United States. This approach was to take a snapshot of the wealth distribution of the top 0.1% and the bottom 50% at the start of Q4 2019 and forecast the change in wealth from changes in asset prices. Conclusive evidence from this paper and from prior research indicates that wealth inequality and the Federal Reserves monetary policy are inversely proportional; in other words, as the FED loosens its policy, wealth inequality expands.