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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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References

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  1. Willem Thorbecke, 1998. "On Stock Market Returns and Monetary Policy," Macroeconomics, EconWPA 9812009, EconWPA.
  2. Jeff Fuhrer & Geoff Tootell, 2004. "Eyes on the prize: how did the Fed respond to the stock market?," Public Policy Discussion Paper, Federal Reserve Bank of Boston 04-2, Federal Reserve Bank of Boston.
  3. Patelis, Alex D, 1997. " Stock Return Predictability and the Role of Monetary Policy," Journal of Finance, American Finance Association, American Finance Association, vol. 52(5), pages 1951-72, December.
  4. Ben Bernanke & Kenneth N. Kuttner, 2003. "What explains the stock market's reaction to Federal Reserve policy?," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue Mar.
  5. Roberto Rigobon & Brian Sack, 2002. "The impact of monetary policy on asset prices," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2002-4, Board of Governors of the Federal Reserve System (U.S.).
  6. Roberto Rigobon & Brian Sack, 2003. "Measuring The Reaction Of Monetary Policy To The Stock Market," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 118(2), pages 639-669, May.
  7. Refet S Gürkaynak & Brian Sack & Eric Swanson, 2005. "Do Actions Speak Louder Than Words? The Response of Asset Prices to Monetary Policy Actions and Statements," International Journal of Central Banking, International Journal of Central Banking, International Journal of Central Banking, vol. 1(1), May.
  8. Francesco Furlanetto, 2008. "Does monetary policy react to asset prices? Some international evidence," Working Paper, Norges Bank 2008/07, Norges Bank.
  9. Stefania D'Amico & Mira Farka, 2011. "The Fed and the Stock Market: An Identification Based on Intraday Futures Data," Journal of Business & Economic Statistics, Taylor & Francis Journals, Taylor & Francis Journals, vol. 29(1), pages 126-137, January.
  10. Paul A. Samuelson, 1958. "An Exact Consumption-Loan Model of Interest with or without the Social Contrivance of Money," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 66, pages 467.
  11. Manuel S. Santos & Michael Woodford, 1993. "Rational Asset Pricing Bubbles," Working Papers, Centro de Investigacion Economica, ITAM 9304, Centro de Investigacion Economica, ITAM.
  12. Galí, Jordi & Gambetti, Luca, 2008. "On the Sources of the Great Moderation," CEPR Discussion Papers, C.E.P.R. Discussion Papers 6632, C.E.P.R. Discussion Papers.
  13. Tirole, Jean, 1985. "Asset Bubbles and Overlapping Generations," Econometrica, Econometric Society, Econometric Society, vol. 53(6), pages 1499-1528, November.
  14. Ben S. Bernanke & Mark Gertler, 2001. "Should Central Banks Respond to Movements in Asset Prices?," American Economic Review, American Economic Association, American Economic Association, vol. 91(2), pages 253-257, May.
  15. Philip Lowe & Claudio Borio, 2002. "Asset prices, financial and monetary stability: exploring the nexus," BIS Working Papers, Bank for International Settlements 114, Bank for International Settlements.
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Cited by:
  1. Francesco Furlanetto & Francesco Ravazzolo & Samad Sarferaz, 2014. "Identification of financial factors in economic fluctuations," Working Paper, Norges Bank 2014/09, Norges Bank.
  2. Zhang, Tongbin, 2014. "Stock Price, Real Riskless Interest Rate and Learning," MPRA Paper 57090, University Library of Munich, Germany.
  3. Leroi Raputsoane, 2014. "Disaggregated Credit Extension and Financial Distress in South Africa," Working Papers, Economic Research Southern Africa 435, Economic Research Southern Africa.

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