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The Fed and Stock Market: A Proxy and Instrumental Variable Identification

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Author Info
d'Amico, Stefania (Columbia University)
Mira Farka
Abstract

Stock market fluctuations are likely to be an important determinant of monetary policy decisions because of their potential impact on macroeconomy. At the same time, innovations in fed fund rates affect stock prices as they change the expected future real interest rates. In this paper we apply a new identification procedure, based on proxy and IV variables, to estimate the contemporaneous relations between stock market and monetary policy without imposing any exclusion restrictions on the parameters of interest. Our empirical results indicate: first, that monetary policy responds in a positive fashion to contemporaneous changes in the stock market, but this relationship is not significant; second, that stock returns respond negatively to a positive monetary policy shock and that this response is significant at 1% level. This estimation analysis, while indicating that stock market participants react strongly and significantly to monetary policy innovations, seems to confirm the fact that in the past the Fed has not directly targeted asset prices in the conduct of monetary policy.

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Publisher Info
Paper provided by Royal Economic Society in its series Royal Economic Society Annual Conference 2003 with number 52.

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Date of creation: 04 Jun 2003
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Handle: RePEc:ecj:ac2003:52

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Web page: http://www.res.org.uk/society/annualconf.asp
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Related research
Keywords: monetary policy; financial markets; structural VAR; identification;

Find related papers by JEL classification:
E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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  1. 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. [Downloadable!]
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