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U.S. Monetary Policy and Stock Prices: Should the Fed Attempt to Control Stock Prices?

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  • John, Tatom

Abstract

This article rejects the linkages in proposals that the Federal Reserve Bank (Fed) target equity prices. The real federal funds rate (RFF) and stock prices (SP) are uncorrelated; causality tests show a positive effect of SP on RFF and a negative effect of SP on RFF. These results occur as part of the dynamics of a negative cointegrated relationship between SP and RFF. A theoretically expected inverse relation between SP and inflation accounts for the results. The negative effect of SP on FF is also confirmed in a Taylor Rule estimate. Higher stock prices anticipate lower, not higher, inflation.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 19762.

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Date of creation: 01 Dec 2009
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Handle: RePEc:pra:mprapa:19762

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Keywords: Monetary Policy; Bubbles; Asset Prices; Inflation.;

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  1. Steven A. Sharpe, 2002. "Reexamining Stock Valuation and Inflation: The Implications Of Analysts' Earnings Forecasts," The Review of Economics and Statistics, MIT Press, vol. 84(4), pages 632-648, November.
  2. Frank Smets, 1997. "Financial-asset Prices and Monetary Policy: Theory and Evidence," RBA Annual Conference Volume, Reserve Bank of Australia, in: Philip Lowe (ed.), Monetary Policy and Inflation Targeting Reserve Bank of Australia.
  3. 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.
  4. Ben Bernanke & Mark Gertler, 1999. "Monetary policy and asset price volatility," Economic Review, Federal Reserve Bank of Kansas City, Federal Reserve Bank of Kansas City, issue Q IV, pages 17-51.
  5. John A. Tatom & James E. Turley, 1978. "Inflation and taxes: disincentives for capital formation," Review, Federal Reserve Bank of St. Louis, Federal Reserve Bank of St. Louis, issue Jan, pages 2-8.
  6. Fama, Eugene F, 1981. "Stock Returns, Real Activity, Inflation, and Money," American Economic Review, American Economic Association, American Economic Association, vol. 71(4), pages 545-65, September.
  7. James R. Booth & Lena Chua Booth, 1997. "Economic factors, monetary policy and expected returns on stocks and bonds," Economic Review, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, pages 32-42.
  8. Jensen, Gerald R. & Mercer, Jeffrey M. & Johnson, Robert R., 1996. "Business conditions, monetary policy, and expected security returns," Journal of Financial Economics, Elsevier, Elsevier, vol. 40(2), pages 213-237, February.
  9. Marcus Miller & Paul Weller & Lei Zhang, 2000. "Moral Hazard and the US Stock Market: Has Mr. Greenspan Created a Bubble?," Econometric Society World Congress 2000 Contributed Papers, Econometric Society 1902, Econometric Society.
  10. John B. Taylor, 1999. "A Historical Analysis of Monetary Policy Rules," NBER Chapters, in: Monetary Policy Rules, pages 319-348 National Bureau of Economic Research, Inc.
  11. James H. Stock & Mark W.Watson, 2003. "Forecasting Output and Inflation: The Role of Asset Prices," Journal of Economic Literature, American Economic Association, American Economic Association, vol. 41(3), pages 788-829, September.
  12. James B. Bullard & Eric Schaling, 2002. "Why the Fed should ignore the stock market," Review, Federal Reserve Bank of St. Louis, Federal Reserve Bank of St. Louis, issue Mar., pages 35-42.
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