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Stock Market Uncertainty and Monetary Policy Reaction Functions of the Federal Reserve Bank

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  • Mario Jovanovic

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  • Tobias Zimmermann
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    Abstract

    In this paper we examine the link between stock market uncertainty and monetary policy in the US. There are strong arguments why central banks should account for stock market uncertainty in their strategy. Amongst others, they can maintain the functioning of financial markets and moderate possible economic downswings. To describe the behavior of the Federal Reserve Bank, augmented forward-looking Taylor rules are estimated by GMM. The standard specification is expanded by a measure for stock market uncertainty, which is estimated by an exponential GARCH-model.We show that, given a certain level of inflation and output, US central bank rates are significantly lower when stock market uncertainty is high and vice versa. These results are achieved by using the federal funds rate from 1980:10 to 2007:7.

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    Bibliographic Info

    Paper provided by Rheinisch-Westfälisches Institut für Wirtschaftsforschung, Ruhr-Universität Bochum, Universität Dortmund, Universität Duisburg-Essen in its series Ruhr Economic Papers with number 0077.

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    Length: 19 pages
    Date of creation: Nov 2008
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    Handle: RePEc:rwi:repape:0077

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    Related research

    Keywords: Monetary policy rules; financial markets; stock market uncertainty; EGARCH;

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    1. 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.
    2. Kai Carstensen, 2006. "Estimating the ECB Policy Reaction Function," German Economic Review, Verein für Socialpolitik, vol. 7, pages 1-34, 02.
    3. Choudhry, Taufiq, 2003. "Stock market volatility and the US consumer expenditure," Journal of Macroeconomics, Elsevier, vol. 25(3), pages 367-385, September.
    4. Tim Bollerslev, 1986. "Generalized autoregressive conditional heteroskedasticity," EERI Research Paper Series EERI RP 1986/01, Economics and Econometrics Research Institute (EERI), Brussels.
    5. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-54, July.
    6. Siklos, Pierre L. & Werner, Thomas & Bohl, Martin T., 2004. "Asset Prices in Taylor Rules: Specification, Estimation, and Policy Implications for the ECB," Discussion Paper Series 1: Economic Studies 2004,22, Deutsche Bundesbank, Research Centre.
    7. Nelson, Daniel B, 1991. "Conditional Heteroskedasticity in Asset Returns: A New Approach," Econometrica, Econometric Society, vol. 59(2), pages 347-70, March.
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