A vicious circle between markets and policy
The interaction of markets and policy is actually a full circle. Not only are firm valuations affected by Fed policy, but the Fed also interprets data from the economy, including stock market price levels as additional noisy signals with which to set their policy.
The Interaction of Markets and Policy: A Corporate Finance Perspective
Author: Laurie Simon Hodrick
From: Hoover Institution – Stanford University
Suggestions for improvement
[T]he Fed’s excessive fine-tuning of the economy and financial markets — much of which is unnecessary to achieve its longer-run dual mandate — has created an environment of gamesmanship and “tilts” that have added financial market volatility and harmed economic performance.
Mickey Levy suggests the following changes:
- The Fed should be more circumspect about its ability to extract reliable economic signals from the stock market.
- The Fed should not respond publicly to high frequency data.
- The Fed should revamp the quarterly Summary of Economic Projections by introducing uncertainties and highlighting the conditionality of monetary policy.
The Fed and Financial Markets: Suggestions to Improve an Unhealthy Relationship
Author: Mickey D. Levy
From: Berenberg Capital Markets