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What explains the stock market's reaction to Federal Reserve policy?

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  • Ben Bernanke
  • Kenneth N. Kuttner

Abstract

This paper analyzes the impact of unanticipated changes in the Federal funds target on equity prices, with the aim of both estimating the size of the typical reaction, and understanding the reasons for the market's response. On average over the May 1989 to December 2001 sample, a "typical" unanticipated 25 basis point rate cut has been associated with a 1.3 percent increase in the S&P 500 composite index. The estimated response varies considerably across industries, with the greatest sensitivity observed in cyclical industries like construction, and the smallest in mining and utilities. Very little of the market's reaction can be attributed to policy's effects on the real rate of interest or future dividends, however. Instead, most of the response of the current excess return on equities can be traced to policy's impact on expected future excess returns.

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Bibliographic Info

Article provided by Federal Reserve Bank of San Francisco in its journal Proceedings.

Volume (Year): (2003)
Issue (Month): Mar ()
Pages:

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Handle: RePEc:fip:fedfpr:y:2003:i:mar:x:1

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  1. Kenneth N. Kuttner, 2000. "Monetary policy surprises and interest rates: evidence from the Fed funds futures markets," Staff Reports 99, Federal Reserve Bank of New York.
  2. Refet S. G├╝rkaynak & Brian Sack & Eric Swanson, 2002. "Market-based measures of monetary policy expectations," Finance and Economics Discussion Series 2002-40, Board of Governors of the Federal Reserve System (U.S.).
  3. Willem Thorbecke, 1998. "On Stock Market Returns and Monetary Policy," Macroeconomics 9812009, EconWPA.
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  5. Goto, Shingo, 2000. "The Fed's Effect on Excess Returns and Inflation is Much Bigger Than You Think," University of California at Los Angeles, Anderson Graduate School of Management qt04f1z5hb, Anderson Graduate School of Management, UCLA.
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  12. Faust Jon & Swanson Eric T & Wright Jonathan H, 2004. "Do Federal Reserve Policy Surprises Reveal Superior Information about the Economy?," The B.E. Journal of Macroeconomics, De Gruyter, vol. 4(1), pages 1-31, October.
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  17. William Poole & Robert H & Rasche & Daniel L. Thornton, 2002. "Market anticipations of monetary policy actions," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 65-94.
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  23. d'Amico, Stefania & Mira Farka, 2003. "The Fed and Stock Market: A Proxy and Instrumental Variable Identification," Royal Economic Society Annual Conference 2003 52, Royal Economic Society.
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