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The response of asset prices to monetary policy shocks: stronger than thought

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  • Alessi, Lucia
  • Kerssenfischer, Mark

Abstract

Mainstream macroeconomic theory predicts a rapid response of asset prices to monetary policy shocks, which conventional empirical models are unable to reproduce. We argue that this is due to a deficient information set: Forward-looking economic agents observe vastly more information than the handful of variables included in standard VAR models. Thus, small-scale VARs are likely to suffer from nonfundamentalness and yield biased results. We tackle this problem by estimating a Structural Factor Model for a large euro area dataset. We find quicker and larger effects of monetary policy shocks, consistent with mainstream theory and the observed large swings in asset prices. Our results point to stronger financial stability consequences of an exogenous monetary policy tightening, also in the form of a quicker than expected unwinding of QE, than commonly thought. JEL Classification: C32, E43, E44, E52

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  • Alessi, Lucia & Kerssenfischer, Mark, 2016. "The response of asset prices to monetary policy shocks: stronger than thought," Working Paper Series 1967, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:20161967
    Note: 1023254
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    3. Mumtaz, Haroon & Theodoridis, Konstantinos, 2020. "Fiscal policy shocks and stock prices in the United States," European Economic Review, Elsevier, vol. 129(C).
    4. Christophe Blot & Paul Hubert & Fabien Labondance, 2020. "The asymmetric effects of monetary policy on stock price bubbles," Working Papers hal-03403075, HAL.
    5. Gries, Thomas & Mitschke, Alexandra, 2019. "Systemic instability of the interbank credit market: A contribution to a resilient financial system," VfS Annual Conference 2019 (Leipzig): 30 Years after the Fall of the Berlin Wall - Democracy and Market Economy 203582, Verein für Socialpolitik / German Economic Association.
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    7. Jonas Meier, 2020. "Multivariate Distribution Regression," Diskussionsschriften dp2023, Universitaet Bern, Departement Volkswirtschaft.
    8. Amat Adarov, 2017. "Financial Cycles in Credit, Housing and Capital Markets: Evidence from Systemic Economies," wiiw Working Papers 140, The Vienna Institute for International Economic Studies, wiiw.
    9. Lake, A., 2020. "Behavioural Finance at Home: Testing Deviations of House Prices from their Fundamental Values," Cambridge Working Papers in Economics 20104, Faculty of Economics, University of Cambridge.
    10. Barigozzi, Matteo & Lippi, Marco & Luciani, Matteo, 2021. "Large-dimensional Dynamic Factor Models: Estimation of Impulse–Response Functions with I(1) cointegrated factors," Journal of Econometrics, Elsevier, vol. 221(2), pages 455-482.
    11. Christophe Blot & Fabien Labondance, 2021. "Beyond the Interest Rate Pass-through: Monetary Policy and Banks Interest Rates during the Effective Lower Bound," Working Papers 2021-03, CRESE.
    12. Juho Koistinen & Bernd Funovits, 2022. "Estimation of Impulse-Response Functions with Dynamic Factor Models: A New Parametrization," Papers 2202.00310, arXiv.org, revised Feb 2022.
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    14. Mirela S. Miescu & Haroon Mumtaz, 2019. "Proxy structural vector autoregressions, informational sufficiency and the role of monetary policy," Working Papers 894, Queen Mary University of London, School of Economics and Finance.

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    More about this item

    Keywords

    Asset Prices; monetary policy; Nonfundamentalness.; Structural Factor Models;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • 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

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