Monetary Policy Should Consider Asset Prices

(b) To determine Policy Portfolio by using mean-variance analysis. Given a variable number of expected portfolio return, we would choose our strategy from a set of minimum-variance portfolio basing on our tolerance for risk.

In fact, an article by Fazel Shokoofeh questions the effectiveness of monetary policy “with respect to affecting mortgage rate and thus investment and aggregate demand” (Shokoofeh

Most people don’t understand Economic growth or what takes place in the economy with regard to inflation, unemployment, or interest rates. These things are all regulated by the central bank called the Federal Reserve System. The tope covered in this paper is the monetary policy which is the policy that decides if unemployment, interest, and inflation decreases or increases. The Monetary policy decides what price a person pays for an item at the store, how much interest a person will get charged on a loan for a car. This is something most people consider, most just look for the best price point or look where their money can go the farthest.

Monetary policy focuses on keeping interest rates at a modest level, keeping prices steady, and keeping unemployment low. The Federal Open Market Committee is responsible for making the necessary monetary policy changes. These changes influence both the markets within the United States and the markets internationally. Currently, there is a lot of volatility within the markets, and there is a lot of speculation about if and when the Federal Reserve will raise interest rates. There is also speculation about whether a negative interest rate would work to get the economy back on target. Also, many worry about whether the current government debt level will continue, and with the number of people entering retirement increasing, whether there will be enough money coming in to cover the costs of the social programs, such as Social Security and Medicare.

In this case, Fed is unlikely to tight money supply by increasing federal funds rate, which is currently zero and is a frequently debatable topic. Such policy has a positive impact on a stock market.

The FED decided to carry out its bond purchasing program in August to help prevent deflation (Hauser, 2011). The article could have turned out much differently if the FED did not step up and take action. In addition the FED has the authority to adjust interest rates in accordance with the current economic condition. Currently the FED is willing to curb inflation by adjusting the interest rates at a moment’s notice (Hauser, 2011). The FED’s invisible hand can sometimes help prevent major economic disasters.

James Bullard from the St Louis Fed, said recently that the increase in asset prices was not sufficient proof of quantitative easing’s guilt in raising inequality because asset valuations are more normal now than they in the years after the financial crisis. “This suggests that quantitative easing had no medium term implications for U.S. income and/or wealth distribution. It is only as good or bad as it was before the crisis”.

Throughout last year, the media were solely focussed on the differences of opinion on the Federal Open Market Committee (FOMC) between the doves and hawks as being solely about the projected increase in the federal funds rate. The baseline outlook proposed by Chair Yellen was for a glacial trajectory, but this was always subject to alteration depending on the underlying tone of incoming economic data. Since the financial crisis, however, US monetary policy has been underpinned by two separate pillars: 1) asset purchases, and 2) a zero-bound federal funds rate. Divisions of opinion between hawks and doves were evident before the onset of tapering asset purchases in 2014, and they

Theories about how the economy works and what will happen in the economy where there is monetary policy or fiscal policy intervention are appropriate in assisting policy-makers understand the possible implications of decisions they make or are under consideration. However, they are rarely complete models and often outcomes cannot be predicted. Reintroduction of a theory suggests that new evidence in support of the theory has been reported.

‘The Capital asset pricing model (CAPM) is a very useful model and it is used widely in the industry even though it is based on very strong assumptions. Discuss in the light of recent developments in the area.’

According to the CAPM model:R_i=α+βR_m+ε, α represent the abnormal return gained by the portfolio. If the market is efficiency, the α has to be zero.

Gurkaynak, Sack and Swanson (2004) investigates the response of asset prices to monetary policy actions and statements, using a high frequency event-study analysis similar Craine and Martin (2004), they recognised that the change in assets prices are not accurately

The economic forecasting staff for Merrill Finch developed probability estimates for the state of the economy, and the security analysts have developed software to estimate the rate of return on each of these alternatives under each state of the economy. A chart showing the results of the analysis is in Appendix A of this report.

In a world without uncertainty the rational approach would be (1) to maximize profits and (2) to maximize market value. When uncertainty arises, these statements vanish and change into a utility maximization. The goal is to get more insight in the effect of financial structure on market valuations.

During this time period, prices for the stocks increase substantially, accordingly reducing risk premium demanded by the traders. Also, shares should amount from 30 to 55 percent of the entire investment portfolio to optimize the investor’s expected profitability. Proximity of the evaluated results to the reality reveals excellence of the myopic loss aversion model (Siegel and Thaler, 1997).