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Is there any evidence of a Greenspan put?

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  • Hall Pamela
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    Abstract

    Central banks have won in credibility as from the mid-eighties by keeping inflation under control. However, confidence in low inflation might have encouraged agents to excessive risk-taking, leading asset prices to rise. Moreover, the belief in a Federal Reserve guarantee against a sharp market decline spread across US markets as from the nineties. This belief, commonly referred to as the Greenspan put, raised again the question about the role of asset prices in monetary policy decisions. The problem is addressed by modeling the reaction of the Fed to stockmarket deviations from fundamentals over the period stretching from August 1987 to October 2008, which corresponds to the periods where Greenspan until January 2006 and Bernanke from thereon were chairmen. A Taylor rule describing the Fed's nominal feedback rule to inflation and economic activity on a monthly basis is extended to take account of asset prices. The indicators considered are deflation and volatility in stock prices. Furthermore, a Markov switching process allows to capture contemporaneous as well as forward-looking monetary policy responses to asset prices over the period. We find out that taking asset price deflation improves the Taylor rule fit by some 8%. In periods when the Fed was actively pursuing an expansive or restrictive monetary policy, its reaction to volatility or deflation of financial markets was significant. We also see that the reaction of the Fed to asset prices was greater during financial crises, especially when modeling a forward-looking decision process. Agents' confidence in a stronger response of the US central bank to significant market declines urging to an easing of monetary conditions in their favour was therefore not unfounded.

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    Bibliographic Info

    Paper provided by Swiss National Bank in its series Working Papers with number 2011-06.

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    Length: 38 pages
    Date of creation: 2011
    Date of revision:
    Handle: RePEc:snb:snbwpa:2011-06

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    Keywords: monetary policy; nominal feedback rule; asset prices; United States;

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    1. Kim, Chang-Jin, 1994. "Dynamic linear models with Markov-switching," Journal of Econometrics, Elsevier, Elsevier, vol. 60(1-2), pages 1-22.
    2. Richard Clarida & Jordi Gali & Mark Gertler, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," NBER Working Papers 6442, National Bureau of Economic Research, Inc.
    3. Thomas Laubach & John C. Williams, 2003. "Measuring the Natural Rate of Interest," The Review of Economics and Statistics, MIT Press, vol. 85(4), pages 1063-1070, November.
    4. Gerlach-Kristen Petra, 2004. "Interest-Rate Smoothing: Monetary Policy Inertia or Unobserved Variables?," The B.E. Journal of Macroeconomics, De Gruyter, De Gruyter, vol. 4(1), pages 1-19, March.
    5. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1997. "Monetary Policy Rules in Practice: Some International Evidence," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1750, C.E.P.R. Discussion Papers.
    6. 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.
    7. Chang-Jin Kim & Charles R. Nelson, 1999. "State-Space Models with Regime Switching: Classical and Gibbs-Sampling Approaches with Applications," MIT Press Books, The MIT Press, The MIT Press, edition 1, volume 1, number 0262112388, December.
    8. John B. Taylor, 1999. "A Historical Analysis of Monetary Policy Rules," NBER Chapters, National Bureau of Economic Research, Inc, in: Monetary Policy Rules, pages 319-348 National Bureau of Economic Research, Inc.
    9. Sellin, Peter, 1998. "Monetary Policy and the Stock Market: Theory and Empirical Evidence," Working Paper Series, Sveriges Riksbank (Central Bank of Sweden) 72, Sveriges Riksbank (Central Bank of Sweden).
    10. Kim, C.-J.Chang-Jin, 2004. "Markov-switching models with endogenous explanatory variables," Journal of Econometrics, Elsevier, Elsevier, vol. 122(1), pages 127-136, September.
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    Cited by:
    1. Ravn, Søren Hove, 2014. "Asymmetric monetary policy towards the stock market: A DSGE approach," Journal of Macroeconomics, Elsevier, Elsevier, vol. 39(PA), pages 24-41.

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