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Monetary Policy Effects on Long-term Rates and Stock Prices

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  • Ranaldo, Angelo

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  • Reynard, Samuel

    ()

Abstract

This paper explains the effects of monetary policy surprises on long-term interest rates and stock prices in terms of changes in expected inflation, real interest rate and dividend growth, and relates these effects to markets’ perceptions of economic shocks and Fed’s information set. We analyze stock and bond futures price co-movements and relate them to Treasury Inflation-Protected Securities (TIPS) data. The sign of long-term interest rate reactions is mostly driven by changes in expected inflation. The sign of stock price reactions is mostly driven by changes in expected dividend growth, but it is also sometimes determined by changes in expected real rates. The co-movements of long-term interest rates and stock prices are determined by the co-movements of expected inflation and dividend growth. The majority of Fed’s interest rate surprises are expected to be followed by negative co-movements between inflation and output. This can be due to relatively more frequent “inflation” or “supply” shocks together with Fed’s private information. Most Fed’s actions are perceived as reactions to economic shocks rather than true policy shocks.

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File URL: http://www1.vwa.unisg.ch/RePEc/usg/sfwpfi/WPF-1322.pdf
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Bibliographic Info

Paper provided by University of St. Gallen, School of Finance in its series Working Papers on Finance with number 1322.

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Length: 35 pages
Date of creation: Nov 2013
Date of revision:
Handle: RePEc:usg:sfwpfi:2013:22

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  1. Refet Gurkaynak & Brian Sack & Eric Swanson, 2005. "Do Actions Speak Louder than Words? The Response of Asset Prices to Monetary Policy Actions and Statements," Macroeconomics 0504013, EconWPA.
  2. Refet S. Gürkaynak & Brian Sack & Eric Swanson, 2005. "The Sensitivity of Long-Term Interest Rates to Economic News: Evidence and Implications for Macroeconomic Models," American Economic Review, American Economic Association, vol. 95(1), pages 425-436, March.
  3. Kenneth N. Kuttner, 2000. "Monetary policy surprises and interest rates: evidence from the Fed funds futures markets," Staff Reports 99, Federal Reserve Bank of New York.
  4. Demiralp, Selva & Jorda, Oscar, 2004. "The Response of Term Rates to Fed Announcements," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 36(3), pages 387-405, June.
  5. Ellingsen, Tore & Söderström, Ulf, 1998. "Monetary Policy and Market Interest Rates," Working Paper Series in Economics and Finance 242, Stockholm School of Economics, revised 08 Mar 1999.
  6. Ben S. Bernanke & Kenneth N. Kuttner, 2005. "What Explains the Stock Market's Reaction to Federal Reserve Policy?," Journal of Finance, American Finance Association, vol. 60(3), pages 1221-1257, 06.
  7. David H. Romer & Christina D. Romer, 2000. "Federal Reserve Information and the Behavior of Interest Rates," American Economic Review, American Economic Association, vol. 90(3), pages 429-457, June.
  8. Campbell, John Y & Ammer, John, 1993. " What Moves the Stock and Bond Markets? A Variance Decomposition for Long-Term Asset Returns," Journal of Finance, American Finance Association, vol. 48(1), pages 3-37, March.
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