Advanced Search
MyIDEAS: Login to save this paper or follow this series

Identifying the Interdependence between US Monetary Policy and the Stock Market

Contents:

Author Info

  • Bjørnland, Hilde C.

    (Dept. of Economics, University of Oslo)

  • Leitemo, Kai

    ()
    (Norwegian School of Management)

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 (CEE 1999). We find great interdependence between interest rate setting and stock prices. Stock prices immediately fall by 1.5 percent due to a monetary policy shock that raises the federal funds rate by ten basis points. A stock price shock increasing stock prices by one percent leads to an increase in the interest rate of five basis points. Stock price shocks are orthogonal to the information set in the VAR model and can be interpreted as non-fundamental shocks. We attribute a major part of the surge in stock prices at the end of the 1990s to these non-fundamental shocks.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.sv.uio.no/econ/english/research/unpublished-works/working-papers/pdf-files/2005/Memo-12-2005.pdf
Download Restriction: no

Bibliographic Info

Paper provided by Oslo University, Department of Economics in its series Memorandum with number 12/2005.

as in new window
Length: 34 pages
Date of creation: 15 May 2005
Date of revision:
Handle: RePEc:hhs:osloec:2005_012

Contact details of provider:
Postal: Department of Economics, University of Oslo, P.O Box 1095 Blindern, N-0317 Oslo, Norway
Phone: 22 85 51 27
Fax: 22 85 50 35
Email:
Web page: http://www.oekonomi.uio.no/indexe.html
More information through EDIRC

Related research

Keywords: VAR; monetary policy; asset prices; identification;

Other versions of this item:

Find related papers by JEL classification:

This paper has been announced in the following NEP Reports:

References

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.:
as in new window
  1. Ben Bernanke & Mark Gertler, 1999. "Monetary policy and asset price volatility," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, Federal Reserve Bank of Kansas City, pages 77-128.
  2. Paul Beaudry & Franck Portier, 2004. "Stock Prices, News and Economic Fluctuations," NBER Chapters, in: Enhancing Productivity (NBER-CEPR-TCER-Keio conference) National Bureau of Economic Research, Inc.
  3. Ravenna, Federico & Walsh, Carl E., 2006. "Optimal monetary policy with the cost channel," Journal of Monetary Economics, Elsevier, Elsevier, vol. 53(2), pages 199-216, March.
  4. Athanasios Orphanides, 2001. "Monetary Policy Rules Based on Real-Time Data," American Economic Review, American Economic Association, vol. 91(4), pages 964-985, September.
  5. Blanchard, Olivier Jean & Quah, Danny, 1989. "The Dynamic Effects of Aggregate Demand and Supply Disturbances," American Economic Review, American Economic Association, vol. 79(4), pages 655-73, September.
  6. Christiano, Lawrence J. & Eichenbaum, Martin & Evans, Charles L., 1999. "Monetary policy shocks: What have we learned and to what end?," Handbook of Macroeconomics, Elsevier, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 2, pages 65-148 Elsevier.
  7. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2005. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 113(1), pages 1-45, February.
  8. Ben S. Bernanke & Kenneth N. Kuttner, 2004. "What explains the stock market's reaction to Federal Reserve policy?," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2004-16, Board of Governors of the Federal Reserve System (U.S.).
  9. Rapach, David E., 2001. "Macro shocks and real stock prices," Journal of Economics and Business, Elsevier, Elsevier, vol. 53(1), pages 5-26.
  10. Clarida, R. & Gali, J. & Gertler, M., 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Working Papers, C.V. Starr Center for Applied Economics, New York University 99-13, C.V. Starr Center for Applied Economics, New York University.
  11. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1908, C.E.P.R. Discussion Papers.
  12. Giorgio Valente, 2003. "Monetary policy rules and regime shifts," Applied Financial Economics, Taylor & Francis Journals, Taylor & Francis Journals, vol. 13(7), pages 525-535.
  13. Ben S. Bernanke & Mark Gertler, 2001. "Should Central Banks Respond to Movements in Asset Prices?," American Economic Review, American Economic Association, vol. 91(2), pages 253-257, May.
  14. Jagjit S. Chadha & Lucio Sarno & Giorgio Valente, 2004. "Monetary Policy Rules, Asset Prices, and Exchange Rates," IMF Staff Papers, Palgrave Macmillan, vol. 51(3), pages 529-552, November.
  15. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, Elsevier, vol. 12(3), pages 383-398, September.
  16. Rudebusch, G.D., 1996. "Do Measures of Monetary Policy in a VAR Make Sense?," Papers, Banca Italia - Servizio di Studi 269, Banca Italia - Servizio di Studi.
  17. Faia, Ester & Monacelli, Tommaso, 2007. "Optimal interest rate rules, asset prices, and credit frictions," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 31(10), pages 3228-3254, October.
  18. Apel, Mikael & Jansson, Per, 2005. "Some Further Evidence on Interest-Rate Smoothing: The Role of Measurement Errors in the Output Gap," Working Paper Series 178, Sveriges Riksbank (Central Bank of Sweden).
  19. Ibrahim Chowdhury & Mathias Hoffmann & Andreas Schabert, 2004. "Inflation Dynamics And The Cost Channel Of Monetary Transmission," Royal Economic Society Annual Conference 2004, Royal Economic Society 80, Royal Economic Society.
  20. Charles T. Carlstrom & Timothy S. Fuerst, 2001. "Monetary policy and asset prices with imperfect credit markets," Economic Review, Federal Reserve Bank of Cleveland, issue Q IV, pages 51-59.
  21. 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.
  22. Ehrmann, Michael & Fratzscher, Marcel, 2004. "Taking stock: monetary policy transmission to equity markets," Working Paper Series, European Central Bank 0354, European Central Bank.
  23. James H. Stock & Mark W. Watson, 2001. "Forecasting output and inflation: the role of asset prices," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue Mar.
  24. Sellin, Peter, 2001. " Monetary Policy and the Stock Market: Theory and Empirical Evidence," Journal of Economic Surveys, Wiley Blackwell, vol. 15(4), pages 491-541, September.
  25. Giordani, Paolo, 2001. "An Alternative Explanation of the Price Puzzle," Working Paper Series 125, Sveriges Riksbank (Central Bank of Sweden).
  26. Roberto Rigobon & Brian P. Sack, 2002. "The Impact of Monetary Policy on Asset Prices," NBER Working Papers 8794, National Bureau of Economic Research, Inc.
  27. Lee, Bong-Soo, 1992. " Causal Relations among Stock Returns, Interest Rates, Real Activity, and Inflation," Journal of Finance, American Finance Association, American Finance Association, vol. 47(4), pages 1591-603, September.
  28. Eric M. Leeper & Christopher A. Sims & Tao Zha, 1996. "What Does Monetary Policy Do?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(2), pages 1-78.
  29. Michael D. Bordo & David C. Wheelock, 2004. "Monetary Policy and Asset Prices: A Look Back at Past U.S. Stock Market Booms," NBER Working Papers 10704, National Bureau of Economic Research, Inc.
  30. Svensson, Lars E. O., 1997. "Inflation forecast targeting: Implementing and monitoring inflation targets," European Economic Review, Elsevier, vol. 41(6), pages 1111-1146, June.
  31. Thorbecke, Willem, 1997. " On Stock Market Returns and Monetary Policy," Journal of Finance, American Finance Association, American Finance Association, vol. 52(2), pages 635-54, June.
  32. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March.
  33. Kaul, Gautam, 1987. "Stock returns and inflation : The role of the monetary sector," Journal of Financial Economics, Elsevier, Elsevier, vol. 18(2), pages 253-276, June.
  34. Jon Faust & Eric M. Leeper, 1994. "When do long-run identifying restrictions give reliable results?," Working Paper, Federal Reserve Bank of Atlanta 94-2, Federal Reserve Bank of Atlanta.
  35. Hanson, Michael S., 2004. "The "price puzzle" reconsidered," Journal of Monetary Economics, Elsevier, Elsevier, vol. 51(7), pages 1385-1413, October.
  36. Nir Jaimovich & Sergio Rebelo, 2006. "Can News About the Future Drive the Business Cycle?," NBER Working Papers 12537, National Bureau of Economic Research, Inc.
  37. Goodhart, Charles & Hofmann, Boris, 2000. "Do Asset Prices Help to Predict Consumer Price Inflation?," Manchester School, University of Manchester, vol. 68(0), pages 122-40, Supplemen.
  38. Rudebusch, Glenn D, 1998. "Do Measures of Monetary Policy in a VAR Make Sense? A Reply," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(4), pages 943-48, November.
  39. Christopher A. Sims, 1992. "Interpreting the Macroeconomic Time Series Facts: The Effects of Monetary Policy," Cowles Foundation Discussion Papers, Cowles Foundation for Research in Economics, Yale University 1011, Cowles Foundation for Research in Economics, Yale University.
  40. Julio J. Rotemberg & Michael Woodford, 1999. "Interest Rate Rules in an Estimated Sticky Price Model," NBER Chapters, in: Monetary Policy Rules, pages 57-126 National Bureau of Economic Research, Inc.
  41. Stefano Neri, 2004. "Monetary policy and stock prices: theory and evidence," Temi di discussione (Economic working papers), Bank of Italy, Economic Research and International Relations Area 513, Bank of Italy, Economic Research and International Relations Area.
  42. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, Econometric Society, vol. 48(1), pages 1-48, January.
  43. Bordo, Michael D & Jeanne, Olivier, 2002. "Boom-Busts in Asset Prices, Economic Instability and Monetary Policy," CEPR Discussion Papers, C.E.P.R. Discussion Papers 3398, C.E.P.R. Discussion Papers.
  44. 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.
  45. Charles T. Carlstrom & Timothy S. Fuerst, 2002. "Imperfect capital markets and nominal wage rigidities," Working Paper 0205, Federal Reserve Bank of Cleveland.
  46. Stephen P Millard & Simon J Wells, 2003. "The role of asset prices in transmitting monetary and other shocks," Bank of England working papers 188, Bank of England.
  47. Eichenbaum, Martin, 1992. "'Interpreting the macroeconomic time series facts: The effects of monetary policy' : by Christopher Sims," European Economic Review, Elsevier, vol. 36(5), pages 1001-1011, June.
  48. Geske, Robert & Roll, Richard, 1983. " The Fiscal and Monetary Linkage between Stock Returns and Inflation," Journal of Finance, American Finance Association, American Finance Association, vol. 38(1), pages 1-33, March.
  49. Bagliano, Fabio-Cesare & Favero, Carlo A, 1997. "Measuring Monetary Policy with VAR Models: An Evaluation," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1743, C.E.P.R. Discussion Papers.
  50. Fuhrer, Jeff & Tootell, Geoff, 2008. "Eyes on the prize: How did the fed respond to the stock market?," Journal of Monetary Economics, Elsevier, Elsevier, vol. 55(4), pages 796-805, May.
  51. James B. Bullard & Eric Schaling, 2002. "Why the Fed should ignore the stock market," Review, Federal Reserve Bank of St. Louis, issue Mar., pages 35-42.
  52. Jon Faust & Eric Swanson & and Jonathan H. Wright, 2002. "Identifying vars based on high frequency futures data," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 720, Board of Governors of the Federal Reserve System (U.S.).
  53. 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.
  54. Lastrapes, W. D., 1998. "International evidence on equity prices, interest rates and money," Journal of International Money and Finance, Elsevier, Elsevier, vol. 17(3), pages 377-406, June.
  55. Vickers, John, 2000. "Monetary Policy and Asset Prices," Manchester School, University of Manchester, vol. 68(0), pages 1-22, Supplemen.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
This item has more than 25 citations. To prevent cluttering this page, these citations are listed on a separate page.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:hhs:osloec:2005_012. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Rhiana Bergh-Seeley).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.