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The Effects of Monetary Policy on Stock Market Bubbles: Some Evidence

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  • Jordi Galí
  • Luca Gambetti

Abstract

We estimate the response of stock prices to exogenous monetary policy shocks using a vector-autoregressive model with time-varying parameters. Our evidence points to protracted episodes in which, after a a short-run decline, stock prices increase persistently in response to an exogenous tightening of monetary policy. That response is clearly at odds with the "conventional" view on the effects of monetary policy on bubbles, as well as with the predictions of bubbleless models. We also argue that it is unlikely that such evidence be accounted for by an endogenous response of the equity premium to the monetary policy shocks.

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Bibliographic Info

Paper provided by Barcelona Graduate School of Economics in its series Working Papers with number 724.

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Date of creation: Dec 2013
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Handle: RePEc:bge:wpaper:724

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Keywords: leaning against the wind policies; financial stability; inflation targeting; asset price booms;

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  1. Roberto Rigobon & Brian Sack, 2001. "Measuring the Reaction of Monetary Policy to the Stock Market," NBER Working Papers 8350, National Bureau of Economic Research, Inc.
  2. D’Amico, Stefania & Farka, Mira, 2011. "The Fed and the Stock Market: An Identification Based on Intraday Futures Data," Journal of Business & Economic Statistics, American Statistical Association, vol. 29(1), pages 126-137.
  3. Francesco Furlanetto, 2008. "Does monetary policy react to asset prices? Some international evidence," Working Paper 2008/07, Norges Bank.
  4. Luca Gambetti & Jordi Galí, 2007. "On the sources of the Great Moderation," Proceedings, Federal Reserve Bank of San Francisco, issue Nov.
  5. Philip Lowe & Claudio Borio, 2002. "Asset prices, financial and monetary stability: exploring the nexus," BIS Working Papers 114, Bank for International Settlements.
  6. Jeff Fuhrer & Geoff Tootell, 2004. "Eyes on the prize: how did the Fed respond to the stock market?," Public Policy Discussion Paper 04-2, Federal Reserve Bank of Boston.
  7. Roberto Rigobon & Brian Sack, 2002. "The impact of monetary policy on asset prices," Finance and Economics Discussion Series 2002-4, Board of Governors of the Federal Reserve System (U.S.).
  8. Patelis, Alex D, 1997. " Stock Return Predictability and the Role of Monetary Policy," Journal of Finance, American Finance Association, vol. 52(5), pages 1951-72, December.
  9. Ben S. Bernanke & Kenneth N. Kuttner, 2003. "What explains the stock market's reaction to Federal Reserve policy?," Staff Reports 174, Federal Reserve Bank of New York.
  10. Ben S. Bernanke & Mark Gertler, 2001. "Should Central Banks Respond to Movements in Asset Prices?," American Economic Review, American Economic Association, vol. 91(2), pages 253-257, May.
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