Learning about the Interdependence between the Macroeconomy and the Stock Market

How strong is the interdependence between the macroeconomy and the stock market? This paper estimates a structural model with nominal rigidities, which includes a wealth effect from asset price fluctuations to consumption, to assess the importance of interactions between the stock market, macroeconomic variables, and monetary policy. The paper relaxes the assumption of rational expectations and assumes that economic agents are learning over time and form near-rational expectations from their perceived model of the economy. The stock market, therefore, affects the economy through two channels: through the described “wealth channel” and through its effect on agents’ expectations. Monetary policy decisions also affect and are potentially affected by the stock market. The model is estimated by full-information Bayesian methods. The results show that the direct wealth effect of asset prices on consumption is minor, but asset price fluctuations have had important effects on output expectations. The effect on expectations, however, has considerably varied over time. Moreover, the paper finds that monetary policy seems to have responded with a positive coefficient to changes in the stock market. [PRELIMINARY AND INCOMPLETE VERSION]