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Identifying the interdependence between US monetary policy and the stock market

  • Bjørnland , Hilde

    (University of Oslo, Department of Economics)

  • Leitemo, Kai

    ()

    (Department of Economics, Norwegian School of Management BI)

We estimate the interdependence between US monetary policy and the S&P 500 using structural 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 proper-ties of a monetary policy shock found in the established literature (CEE 1999). We find great interde-pendence between interest rate setting and stock prices. Stock prices immediately fall by 1.5 per cent due to a monetary policy shock that raises the federal funds rate by ten basis points. A stock price shock in-creasing stock prices by one per cent leads to an increase in the interest rate of five basis points. Stock price shocks are orthogonal to the information set in the VAR model and can be interpreted as non-fundamental shocks. We attribute a major part of the surge in stock prices at the end of the 1990s to these non-fundamental shocks.

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File URL: http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/0517netti.pdf
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Paper provided by Bank of Finland in its series Research Discussion Papers with number 17/2005.

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Length: 48 pages
Date of creation: 11 Jul 2005
Date of revision:
Handle: RePEc:hhs:bofrdp:2005_017
Contact details of provider: Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
Web page: http://www.suomenpankki.fi/en/

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