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The Fed and the Stock Market

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Author Info
Paolo Surico
Antonello D'Agostino
Luca Sala

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Abstract

The Fed closely monitors the stock market and the stock market continuously forms expectations about the Fed decisions. What does this imply for the relation between the fed funds rate and the S&P500? We find that the answer depends on the conditions prevailing on the financial market. During periods of high (low) volatility in asset price inflation an unexpected 5 fall in the stock market index implies that the Fed cuts the interest rate by 19 ($6$) basis points while an unanticipated policy tightening of 50 basis points causes a 4.7 (2.3) decline in the S&P500. The Fed reaction to asset price return is however statistically different from zero only in the high volatility regime, whereas the fall in asset price return following an interest rate rise is highly significant during normal times only

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Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2005 with number 293.

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Date of creation: 11 Nov 2005
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Handle: RePEc:sce:scecf5:293

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Keywords: asset price volatility; nonlinear policy; threshold SVAR; system GMM.;

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Find related papers by JEL classification:
E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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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.:
  1. Ben S. Bernanke & Kenneth N. Kuttner, 2004. "What Explains the Stock Market's Reaction to Federal Reserve Policy?," NBER Working Papers 10402, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Bernanke, Ben S. & Gertler, Mark & Gilchrist, Simon, 1999. "The financial accelerator in a quantitative business cycle framework," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 21, pages 1341-1393 Elsevier. [Downloadable!] (restricted)
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  3. Bordo, Michael D & Jeanne, Olivier, 2002. "Boom-Busts in Asset Prices, Economic Instability and Monetary Policy," CEPR Discussion Papers 3398, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  4. 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. [Downloadable!] (restricted)
  5. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1998. "Monetary Policy Shocks: What Have We Learned and to What End?," NBER Working Papers 6400, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  6. Chadha, Jagjit S & Sarno, Lucio & Valente, Giorgio, 2003. "Monetary Policy Rules, Asset Prices and Exchange Rates," CEPR Discussion Papers 4114, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  7. Roberto Rigobon & Brian Sack, 2003. "Measuring The Reaction Of Monetary Policy To The Stock Market," The Quarterly Journal of Economics, MIT Press, vol. 118(2), pages 639-669, May. [Downloadable!] (restricted)
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  8. Rigobon, Roberto & Sack, Brian, 2004. "The impact of monetary policy on asset prices," Journal of Monetary Economics, Elsevier, vol. 51(8), pages 1553-1575, November. [Downloadable!] (restricted)
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  9. Ben Bernanke & Mark Gertler, 1999. "Monetary policy and asset price volatility," Proceedings, Federal Reserve Bank of Kansas City, pages 77-128. [Downloadable!]
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Cited by:
(explanations, 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.)

  1. Mandler, Martin, 2006. "Are there gains from including monetary aggregates and stock market indices in the monetary policy reaction function? A simulation study of recent U.S. monetary policy," MPRA Paper 2318, University Library of Munich, Germany. [Downloadable!]
  2. Cinzia Alcidi & Alessandro Flamini & Andrea Fracasso, 2005. "``Taylored'' Rules. Does One Fit All?," Keele Economics Research Papers KERP 2007/06, Centre for Economic Research, Keele University, revised Mar 2007. [Downloadable!]
  3. Finocchiaro, Daria & Queijo von Heideken, Virginia, 2007. "Do Central Banks React to House Prices?," Working Paper Series 217, Sveriges Riksbank (Central Bank of Sweden). [Downloadable!]
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