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Does the ECB respond to the stock market?

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  • Wouter Botzen, W.J.

    (Vrije Universiteit Amsterdam, Faculteit der Economische Wetenschappen en Econometrie (Free University Amsterdam, Faculty of Economics Sciences, Business Administration and Economitrics)

  • Marey, Philip S.

Abstract

The role of asset prices in monetary policy has been widely debated. This paper examines the role that stock prices play in the monetary policy of the ECB. For this purpose, standard and augmented forward-looking Taylor rules are estimated for the ECB using monthly data between 1999 and 2005. Of special interest is the impact of adding stock prices to the standard Taylor rule of the ECB. The GMM estimations of a standard Taylor rule and augmented Taylor rules for the Euro area indicate that the ECB considered stock price developments in setting interest rates. Monetary policy of the ECB stabilized asset prices by raising interest rates when the stock market index was above average and lowering rates when the index was below average. Stock prices are not only relevant as instruments but also as arguments in the ECB policy rule. The empirical plausibility of the Taylor rule improves when it allows for a reaction to the stock market. These results challenge previous studies.

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Bibliographic Info

Paper provided by VU University Amsterdam, Faculty of Economics, Business Administration and Econometrics in its series Serie Research Memoranda with number 0017.

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Date of creation: 2006
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Handle: RePEc:dgr:vuarem:2006-17

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Web page: http://www.feweb.vu.nl

Related research

Keywords: Taylor rules; Asset prices; ECB monetary policy;

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Cited by:
  1. Hoffmann, Andreas, 2009. "Fear of depression - Asymmetric monetary policy with respect to asset markets," MPRA Paper 17522, University Library of Munich, Germany.

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