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Identifying the interdependence between US monetary policy and the stock market

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Author Info
Hilde C. Bjørnland () (Norwegian School of Management (BI) and Norges Bank (Central Bank of Norway))
Kai Leitemo () (Norwegian School of Management (BI) and Bank of Finland)

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Abstract

We estimate the interdependence between US monetary policy and the S&P 500 using structural VAR methodology. A solution is proposed to the simultaneity problem of identifying monetary and stock price shocks by using a combination of short-run and long-run restrictions that maintains the qualitative properties of a monetary policy shock found in the established literature (Christiano et al., 1999). We find great interdependence between interest rate setting and real stock prices. Real stock prices immediately fall by 7-9 percent due to a monetary policy shock that raises the federal funds rate by 100 basis points. A stock price shock increasing real stock prices by one percent leads to an increase in the interest rate of close to 4 basis points. 1) The capital adequacy ratio 2) Ratio of Residential mortgages to Gross lending 3) An expected loss measure 4) A concentration risk measure 5) The return on assets 6) Norges Bank’s liquidity indicator

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Publisher Info
Paper provided by Norges Bank in its series Working Paper with number 2008/04.

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Length: 28 pages
Date of creation: 10 Apr 2008
Date of revision:
Handle: RePEc:bno:worpap:2008_04

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Related research
Keywords: VAR; monetary policy; asset prices; identification.;

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Find related papers by JEL classification:
E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Determination of Interest Rates; Term Structure of Interest Rates

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Bjørnland, Hilde C., 2005. "Monetary Policy and the Illusionary Exchange Rate Puzzle," Memorandum 26/2005, Oslo University, Department of Economics. [Downloadable!]
    Other versions:
  2. Fabio Milani, 2008. "Learning about the Interdependence between the Macroeconomy and the Stock Market," Working Papers 070819, University of California-Irvine, Department of Economics. [Downloadable!]
  3. Mandler, Martin, 2006. "Are there gains from including monetary aggregates and stock market indices in the monetary policy reaction function? A simulation study of recent U.S. monetary policy," MPRA Paper 2318, University Library of Munich, Germany. [Downloadable!]
  4. Puhakka , Mikko, 2005. "The effects of aging population on the sustainability of fiscal policy," Research Discussion Papers 26/2005, Bank of Finland. [Downloadable!]
  5. Bjørnland, Hilde C., 2005. "Monetary policy and exchange rate interactions in a small open economy," Memorandum 31/2005, Oslo University, Department of Economics. [Downloadable!]
    Other versions:
  6. Bork, Lasse, 2009. "Estimating US Monetary Policy Shocks Using a Factor-Augmented Vector Autoregression: An EM Algorithm Approach," Finance Research Group Working Papers F-2009-03, University of Aarhus, Aarhus School of Business, Department of Business Studies. [Downloadable!]
  7. Lasse Bork, 2009. "Estimating US Monetary Policy Shocks Using a Factor-Augmented Vector Autoregression: An EM Algorithm Approach," CREATES Research Papers 2009-11, School of Economics and Management, University of Aarhus. [Downloadable!]
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