key: cord-1012223-7b6iz1zg
authors: Sunder, Shyam
title: How did the U.S. stock market recover from the Covid-19 contagion?
date: 2020-07-06
journal: Mind Soc
DOI: 10.1007/s11299-020-00238-0
sha: a7ad87d9f7a984ad740cd9674967cce0f13bb90d
doc_id: 1012223
cord_uid: 7b6iz1zg

nan

The FRS has responded to sharp drops in stock prices during the recent two decades by pumping massive amounts of liquidity into the economy. These interventions to induce a price recovery have created a not-so-unreasonable expectation that any future precipitous stock price declines may also elicit a similar response from the central bank, especially during an election year under heavy political pressure. If rising stock prices are considered normal by investors and policymakers, and the latter tend to intervene to engineer a recovery from sharp declines, it does not seem unreasonable to believe (as some do) that the stock market will always go up. This expectation of policy has earned its own moniker of "central bank put".

In addition to the data from the field, a recent experimental research study (Hirota et al. 2020 , forthcoming in JEBO) finds strong evidence that, even in the absence of any doubts about the fundamental value of securities, the presence of more money in the hands of investors generates higher prices in laboratory markets. Figure 2 summarizes the average price data during 16 periods of six low-and six high-liquidity independent sessions that involved a total of 180 human subjects.

The study concludes that the correspondence between prices and fundamental values in security markets requires not only that the investors be rational, but also that they expect the other current and future investors to behave rationally. While the first assumption may hold true, the second one is unlikely to hold true. Even in a world of rational investors, not everyone believes that all others are and will be rational; i.e., belief in the rationality of other investor is unlikely to be common knowledge in the investor community.

In such a world, it should not be a surprise that changes in money supply affect stock prices. Perhaps this helps explain the rise in stock prices in recent months as a response to greatly increased liquidity injected by decisions of the U.S. Federal Reserve.

During the 2008 financial crisis, the QE policies of the U.S. and other developed economies also appeared in the actions of central banks of South Korea and Israel. In 2020, several other developing economies-Hungary, Indonesia, Malaysia, the Philippines, Poland, South Africa, and Turkey-have joined Israel and South Korea with QE programs of their own with varied sizes and goals. The effectiveness of pursuing such policies in the absence of reserve currency status remains uncertain.

Shyam Sunder James L. Frank Professor of Accounting, Economics, and Finance

Speculation and price indeterminacy in financial markets: an experimental study. Cowles Foundation discussion paper 2134R