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Does monetary policy react to asset prices? Some international evidence

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  • Francesco Furlanetto

    ()
    (HEC Lausanne and Norges Bank (Central Bank of Norway))

Abstract

This paper attempts to measure the reaction of monetary policy to the stock market. We apply the procedure of Rigobon and Sack (2003) to identify and estimate a VAR in the presence of heteroskedasticity. This procedure fully takes into account the endogeneity of interest rates and stock returns that is ignored in the traditional VAR literature. We find a positive and significant reaction in the US and the UK. However, since the end of the 1990s, in a period of large stock market fluctuations, this reaction declines in the US and disappears in the UK. In Japan and the EU, we do not find any reaction. We provide evidence that the lower response to stock prices in the last part of the sample in the US is compensated by a higher response to real estate prices.

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Bibliographic Info

Paper provided by Norges Bank in its series Working Paper with number 2008/07.

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Length: 44 pages
Date of creation: 08 May 2008
Date of revision:
Handle: RePEc:bno:worpap:2008_07

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Keywords: Monetary policy; Stock market; Identification; VAR; Heteroskedasticity;

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References

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  1. Filippo Altissimo & Evaggelia Georgiou & Teresa Sastre & Maria Teresa Valderrama & Gabriel Sterne & Marc Stocker & Mark Weth & Karl Whelan & Alpo Willman, 2005. "Wealth and asset price effects on economic activity," Occasional Paper Series 29, European Central Bank.
  2. Gerlach, Stefan & Assenmacher-Wesche, Katrin, 2008. "Financial structure and the impact of monetary policy on asset prices," CFS Working Paper Series 2008/30, Center for Financial Studies (CFS).
  3. Jiri Slacalek, 2006. "What Drives Personal Consumption?: The Role of Housing and Financial Wealth," Discussion Papers of DIW Berlin 647, DIW Berlin, German Institute for Economic Research.
  4. Q. Farooq Akram & Gunnar Bärdsen & Øyvind Eitrheim, 2006. "Monetary policy and asset prices: to respond or not?," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 11(3), pages 279-292.
  5. Francesco FURLANETTO, 2008. "Does Monetary Policy React to Asset Prices? Some International Evidence," Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) 08.02, Université de Lausanne, Faculté des HEC, DEEP.
  6. Antonello D'Agostino & Luca Sala & Paolo Surico, 2005. "The Fed and the Stock Market," Macroeconomics 0507001, EconWPA.
  7. Case Karl E. & Quigley John M. & Shiller Robert J., 2005. "Comparing Wealth Effects: The Stock Market versus the Housing Market," The B.E. Journal of Macroeconomics, De Gruyter, vol. 5(1), pages 1-34, May.
  8. Roberto Rigobon, 2003. "Identification Through Heteroskedasticity," The Review of Economics and Statistics, MIT Press, vol. 85(4), pages 777-792, November.
  9. Jagjit S. Chadha & Lucio Sarno & Giorgio Valente, 2004. "Monetary Policy Rules, Asset Prices and Exchange Rates," CDMA Working Paper Series 200403, Centre for Dynamic Macroeconomic Analysis.
  10. Clarida, Richard & Gali, Jordi & Gertler, Mark, 1998. "Monetary policy rules in practice Some international evidence," European Economic Review, Elsevier, vol. 42(6), pages 1033-1067, June.
  11. Christopher D. Carroll & Misuzu Otsuka & Jirka Slacalek, 2006. "How Large Is the Housing Wealth Effect? A New Approach," Economics Working Paper Archive 535, The Johns Hopkins University,Department of Economics.
  12. Castelnuovo , Efrem & Nisticò, Salvatore, 2010. "Stock market conditions and monetary policy in an DSGE model for the US," Research Discussion Papers 11/2010, Bank of Finland.
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  14. Bjørnland, Hilde C. & Leitemo, Kai, 2009. "Identifying the interdependence between US monetary policy and the stock market," Journal of Monetary Economics, Elsevier, vol. 56(2), pages 275-282, March.
  15. Daria Finocchiaro & Virginia Queijo Heideken, 2013. "Do Central Banks React to House Prices?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 45(8), pages 1659-1683, December.
  16. Akram, Q. Farooq & Eitrheim, Øyvind, 2008. "Flexible inflation targeting and financial stability: Is it enough to stabilize inflation and output?," Journal of Banking & Finance, Elsevier, vol. 32(7), pages 1242-1254, July.
  17. Willem Thorbecke, 1998. "On Stock Market Returns and Monetary Policy," Macroeconomics 9812009, EconWPA.
  18. Bohl, Martin T. & Siklos, Pierre L. & Werner, Thomas, 2007. "Do central banks react to the stock market? The case of the Bundesbank," Journal of Banking & Finance, Elsevier, vol. 31(3), pages 719-733, March.
  19. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules And Macroeconomic Stability: Evidence And Some Theory," The Quarterly Journal of Economics, MIT Press, vol. 115(1), pages 147-180, February.
  20. Monica Paiella, 2004. "Does wealth affect consumption? Evidence for Italy," Temi di discussione (Economic working papers) 510, Bank of Italy, Economic Research and International Relations Area.
  21. Fabio Milani, 2008. "Learning about the Interdependence between the Macroeconomy and the Stock Market," Working Papers 070819, University of California-Irvine, Department of Economics.
  22. Fuhrer, Jeff & Tootell, Geoff, 2008. "Eyes on the prize: How did the fed respond to the stock market?," Journal of Monetary Economics, Elsevier, vol. 55(4), pages 796-805, May.
  23. Matteo Iacoviello, 2002. "House prices, borrowing constraints and monetary policy in the business cycle," Boston College Working Papers in Economics 542, Boston College Department of Economics, revised 06 Dec 2004.
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  26. 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.
  27. Bordo, Michael D & Jeanne, Olivier, 2002. "Monetary Policy and Asset Prices: Does 'Benign Neglect' Make Sense?," International Finance, Wiley Blackwell, vol. 5(2), pages 139-64, Summer.
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Citations

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Cited by:
  1. Airaudo, Marco & Nisticò, Salvatore & Zanna, Luis-Felipe, 2012. "Learning, Monetary Policy and Asset Prices," School of Economics Working Paper Series 2012-12, LeBow College of Business, Drexel University.
  2. Roseline Nyakerario Misati & Esman Morekwa Nyamongo & Lucas Kamau Njoroge & Sheila Kaminchia, 2012. "Feasibility of inflation targeting in an emerging market: evidence from Kenya," Journal of Financial Economic Policy, Emerald Group Publishing, vol. 4(2), pages 146-159, June.
  3. Demir, Ishak, 2012. "ECB Policy Response to the Euro/US Dollar Exchange Rate," MPRA Paper 36744, University Library of Munich, Germany.
  4. Castelnuovo, Efrem & Nisticò, Salvatore, 2010. "Stock market conditions and monetary policy in a DSGE model for the U.S," Journal of Economic Dynamics and Control, Elsevier, vol. 34(9), pages 1700-1731, September.
  5. Francesco Furlanetto, 2011. "Does Monetary Policy React to Asset Prices? Some International Evidence," International Journal of Central Banking, International Journal of Central Banking, vol. 7(3), pages 91-111, September.
  6. Jordi Galí & Luca Gambetti, 2013. "The effects of monetary policy on stock market bubbles: Some evidence," Economics Working Papers 1392, Department of Economics and Business, Universitat Pompeu Fabra, revised Dec 2013.
  7. Dominique Pepin, 2010. "La BCE réagit-elle au prix des actifs financiers ?," Working Papers hal-00963626, HAL.
  8. Kajuth, Florian, 2012. "Identifying the Phillips curve through shifts in volatility," Journal of Macroeconomics, Elsevier, vol. 34(4), pages 975-991.

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