Antonello D'Agostino (ECARES, Universite' Libre de Bruxelles & European Central Bank) Luca Sala (IGIER, Bocconi University) Paolo Surico (Bank of England & University of Bari)
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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 EconWPA in its series Macroeconomics with number
0507001.
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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