Asset prices and macroeconomic outcomes: a survey

Summary

Focus

Since the Great Financial Crisis, there has been a greater recognition of the linkages between asset prices and the real economy. Yet, many issues remain to be explored, including the drivers of asset prices, their quantitative impact on aggregate activity, including consumption and investment, and their international dimensions.

Contribution

This paper sums up the literature on this topic and focuses on three major questions. What are the basic theoretical linkages between asset prices and macroeconomic outcomes? What is the empirical evidence supporting these linkages? What are the main challenges to the theoretical and empirical findings?

The paper reviews the evolution of the literature on the determinants of equity prices, house prices, exchange rates and interest rates and their linkages with macroeconomic outcomes. It discusses possible directions for future research.

Findings

The paper finds asset prices are much more volatile than economic fundamentals would imply. Investment and consumption at times respond differently to changes in asset prices than standard models would suggest. There are limits to the predictive ability of asset prices for real activity. These findings apply both domestically and internationally. Finally, financial imperfections play an important role in explaining the linkages between asset prices and macroeconomic outcomes.

The paper identifies three promising areas for additional work. First, to fill some of the large gaps in microeconomic and sectoral data. Second, to develop models that can better account for the diverse behaviour of agents, financial imperfections, differences in financial and institutional structures across countries, and global linkages and spillovers. Third, to design monetary and other policies which better account for asset prices, especially for small open economies.

Abstract

This paper surveys the literature on the linkages between asset prices and macroeconomic outcomes. It focuses on three major questions. First, what are the basic theoretical linkages between asset prices and macroeconomic outcomes? Second, what is the empirical evidence supporting these linkages? And third, what are the main challenges to the theoretical and empirical findings? The survey addresses these questions in the context of four major asset price categories: equity prices, house prices, exchange rates and interest rates, with a particular focus on their international dimensions. It also puts into perspective the evolution of the literature on the determinants of asset prices and their linkages with macroeconomic outcomes, and discusses possible future research directions.

JEL classification: D53, E21, E32, E44, E51, F36, F44, F65, G01, G10, G12, G14, G15, G21

Keywords: equity prices, exchange rates, house prices, interest rates, credit, output, consumption, investment, real-financial linkages, macrofinancial linkages, imperfections, frictions