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Identifying the interdependence between US monetary policy and the stock market

  • Bjørnland, Hilde C.
  • Leitemo, Kai

We estimate the interdependence between US monetary policy and the S&P 500 using structural vector autoregressive (VAR) methodology. A solution is proposed to the simultaneity problem of identifying monetary and stock price shocks by using a combination of short-run and long-run restrictions that maintains the qualitative properties of a monetary policy shock found in the established literature [Christiano, L.J., Eichenbaum, M., Evans, C.L., 1999. Monetary policy shocks: what have we learned and to what end? In: Taylor, J.B., Woodford, M. (Eds.), Handbook of Macroeconomics, vol. 1A. Elsevier, New York, pp. 65-148]. We find great interdependence between the interest rate setting and real stock prices. Real stock prices immediately fall by seven to nine percent due to a monetary policy shock that raises the federal funds rate by 100 basis points. A stock price shock increasing real stock prices by one percent leads to an increase in the interest rate of close to 4 basis points.

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Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 56 (2009)
Issue (Month): 2 (March)
Pages: 275-282

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Handle: RePEc:eee:moneco:v:56:y:2009:i:2:p:275-282
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505566

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