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

  • Carmen M. Reinhart
  • Vincent Reinhart

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.

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File URL: http://www.nber.org/papers/w16815.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16815.

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Date of creation: Feb 2011
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Publication status: published as Carmen M. Reinhart and Vincent R. Reinhart, 2011. "Limits of Monetary Policy in Theory and Practice," Cato Journal, Cato Journal, Cato Institute, vol. 31(3), pages 427-439, Fall.
Handle: RePEc:nbr:nberwo:16815
Note: IFM ME
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  1. Carmen M. Reinhart & Vincent R. Reinhart, 2010. "After the fall," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 17-60.
  2. Reinhart, Vincent & Simin, Timothy, 1997. "The market reaction to federal reserve policy action from 1989 to 1992," Journal of Economics and Business, Elsevier, vol. 49(2), pages 149-168.
  3. Reinhart, Carmen & Calvo, Guillermo, 2002. "Fear of floating," MPRA Paper 14000, University Library of Munich, Germany.
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