By Mika Inkinen of the Bank's Foreign Exchange Division and Marco Stringa and Kyriaki Voutsinou of the Bank's Macro Financial Analysis Division.
Equity markets have experienced large price movements since the financial crisis began in mid-2007. Understanding the factors that drive equity prices is important for policymakers as they may contain information about the future course of the economy. This article uses a simple model to decompose recent equity price movements into changes in earnings expectations, the risk-free rate and the equity risk premium. Indicative evidence suggests that changes in earnings expectations can account for some, but by no means all, of the shifts in equity prices since mid-2007. Policy actions by central banks and governments are likely to have supported equity prices, for example by lowering government bond yields and reducing the likelihood of more severe downside risks to the economy materialising. The latter may also have contributed to a fall in the implied level of the equity risk premium, which had increased sharply during the financial crisis.