The Fed must explicitly react to movements on the stock market if it values stability and wishes to avoid large consumption and output swings

Over the past few years, the Fed has been blamed for fuelling the post-2001 financial market boom by maintaining record-low interest rates and ignoring the developments on the stock market. But, should central bankers really care about stock market swings when there is so much uncertainty and noise involved? Eddie Gerba returns to this pre-crisis debate and re-examines the ‘consensus’ that monetary policy, by responding heavily to movements in inflation and output, is enough to bring the markets under control and stabilize the economy. Using a macro-financial model, he finds that an economy is better off overall in terms of consumption gains when a policy that explicitly targets stock market developments is adopted.