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Measuring The Reaction of Monetary Policy to the Stock Market

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  • Roberto Rigobon
  • Brian Sack

Abstract

Movements in the stock market can have a significant impact on the macroeconomy and are therefore likely to be an important factor in the determination of monetary policy. However, little is known about the magnitude of the Federal Reserve's reaction to the stock market, in part because the simultaneous response of equity prices to interest rates makes it difficult to estimate. This paper uses an identification technique based on the heteroskedasticity of stock market returns to measure the reaction of monetary policy to the stock market. We find a significant policy response, with a 5 percent rise (fall) in the S&P 500 index increasing the likelihood of a 25 basis point tightening (easing) by about a half.

Suggested Citation

  • Roberto Rigobon & Brian Sack, 2003. "Measuring The Reaction of Monetary Policy to the Stock Market," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 118(2), pages 639-669.
    • Handle: RePEc:oup:qjecon:v:118:y:2003:i:2:p:639-669.
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    File URL: http://hdl.handle.net/10.1162/003355303321675473
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    More about this item

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications

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