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How did the Fed react to the 1990s stock market bubble? Evidence from an extended Taylor rule

Listed author(s):
  • Hayford, M. D.
  • Malliaris, A. G.

AbstractHow did the Federal Reserve Bank react to the stock market bubble of the late 1990s? At a Symposium sponsored by the Federal Reserve Bank of Kansas City in Jackson Hole, Wyoming on August 30, 2002, Chairman Alan Greenspan remarked that economists do not currently have a way to measure a stock market bubble convincingly. He also argued that in the absence of such a measure, it was difficult for the Fed to justify, with some degree of certainty, a preemptive tightening that would likely be necessary to neutralize such a bubble. This paper extends the Taylor Rule methodology to include three measures of stock market overvaluation and confirms Greenspan's statement that the Fed did not neutralize the bubble. However, the extended Taylor Rule methodology also shows that the Fed, perhaps unintentionally, by keeping the Fed funds rate below those suggested by the Taylor Rule, may have actually contributed to the growth of the bubble.

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File URL: http://www.sciencedirect.com/science/article/pii/S0377-2217(03)00906-8
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Article provided by Elsevier in its journal European Journal of Operational Research.

Volume (Year): 163 (2005)
Issue (Month): 1 (May)
Pages: 20-29

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Handle: RePEc:eee:ejores:v:163:y:2005:i:1:p:20-29
Contact details of provider: Web page: http://www.elsevier.com/locate/eor

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  1. Ben S. Bernanke & Mark Gertler, 2001. "Should Central Banks Respond to Movements in Asset Prices?," American Economic Review, American Economic Association, vol. 91(2), pages 253-257, May.
  2. John P. Judd & Glenn D. Rudebusch, 1998. "Taylor's rule and the Fed, 1970-1997," Economic Review, Federal Reserve Bank of San Francisco, pages 3-16.
  3. Stephen G. Cecchetti, 1998. "Policy rules and targets: framing the central banker's problem," Economic Policy Review, Federal Reserve Bank of New York, issue Jun, pages 1-14.
  4. Lars E. O. Svensson, 2002. "Monetary policy and real stabilization," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 261-312.
  5. Stephen G. Cecchetti & Stefan Krause, 2001. "Financial Structure, Macroeconomic Stability and Monetary Policy," NBER Working Papers 8354, National Bureau of Economic Research, Inc.
  6. John B. Taylor, 1999. "A Historical Analysis of Monetary Policy Rules," NBER Chapters,in: Monetary Policy Rules, pages 319-348 National Bureau of Economic Research, Inc.
  7. Roberto Rigobon & Brian Sack, 2001. "Measuring the Reaction of Monetary Policy to the Stock Market," NBER Working Papers 8350, National Bureau of Economic Research, Inc.
  8. Ben S. Bernanke & Mark Gertler, 1999. "Monetary policy and asset price volatility," Economic Review, Federal Reserve Bank of Kansas City, issue Q IV, pages 17-51.
  9. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
  10. Charles L. Evans, 1998. "Real-time Taylor rules and the federal funds futures market," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q III, pages 44-55.
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