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Inflation, Monetary Policy and Stock Market Conditions

  • Michael D. Bordo
  • Michael J. Dueker
  • David C. Wheelock

This paper examines the association between inflation, monetary policy and U.S. stock market conditions during the second half of the 20th century. We estimate a latent variable VAR to examine how macroeconomic and policy shocks affect the condition of the stock market. Further, we examine the contribution of various shocks to market conditions during particular episodes and find evidence that inflation and interest rate shocks had particularly strong impacts on market conditions in the postwar era. Disinflation shocks promoted market booms and inflation shocks contributed to busts. We conclude that central banks can contribute to financial market stability by minimizing unanticipated changes in inflation.

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File URL: http://www.nber.org/papers/w14019.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 14019.

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Date of creation: May 2008
Date of revision:
Handle: RePEc:nbr:nberwo:14019
Note: ME EFG AP
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  1. Ben Bernanke & Kenneth N. Kuttner, 2003. "What explains the stock market's reaction to Federal Reserve policy?," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  2. Fama, Eugene F, 1981. "Stock Returns, Real Activity, Inflation, and Money," American Economic Review, American Economic Association, vol. 71(4), pages 545-65, September.
  3. Rapach, David E., 2001. "Macro shocks and real stock prices," Journal of Economics and Business, Elsevier, vol. 53(1), pages 5-26.
  4. Michael D. Bordo & David C. Wheelock, 2007. "Stock market booms and monetary policy in the twentieth century," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 91-122.
  5. Don Harding & Adrian Pagan, 2006. "The Econometric Analysis of Constructed Binary Time Series," Department of Economics - Working Papers Series 963, The University of Melbourne.
  6. Shiu-Sheng Chen, 2007. "Does Monetary Policy Have Asymmetric Effects on Stock Returns?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(2-3), pages 667-688, 03.
  7. Lee, Bong-Soo, 1992. " Causal Relations among Stock Returns, Interest Rates, Real Activity, and Inflation," Journal of Finance, American Finance Association, vol. 47(4), pages 1591-603, September.
  8. Carmen M. Reinhart & Graciela L. Kaminsky, 1999. "The Twin Crises: The Causes of Banking and Balance-of-Payments Problems," American Economic Review, American Economic Association, vol. 89(3), pages 473-500, June.
  9. 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.
  10. He, Ling T., 2006. "Variations in effects of monetary policy on stock market returns in the past four decades," Review of Financial Economics, Elsevier, vol. 15(4), pages 331-349.
  11. Dueker, Michael & Nelson, Charles R., 2006. "Business-Cycle Filtering Of Macroeconomic Data Via A Latent Business-Cycle Index," Macroeconomic Dynamics, Cambridge University Press, vol. 10(05), pages 573-594, November.
  12. Rapach, David E., 2002. "The long-run relationship between inflation and real stock prices," Journal of Macroeconomics, Elsevier, vol. 24(3), pages 331-351, September.
  13. Philip Lowe & Claudio Borio, 2002. "Asset prices, financial and monetary stability: exploring the nexus," BIS Working Papers 114, Bank for International Settlements.
  14. Marc D. Hayford & A. G. Malliaris, 2004. "Monetary Policy and the U.S. Stock Market," Economic Inquiry, Western Economic Association International, vol. 42(3), pages 387-401, July.
  15. Adrian R. Pagan & Kirill A. Sossounov, 2003. "A simple framework for analysing bull and bear markets," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 18(1), pages 23-46.
  16. Michael J. Dueker, 2003. "Dynamic forecasts of qualitative variables: a Qual VAR model of U.S. recessions," Working Papers 2001-012, Federal Reserve Bank of St. Louis.
  17. Fama, Eugene F. & Schwert, G. William, 1977. "Asset returns and inflation," Journal of Financial Economics, Elsevier, vol. 5(2), pages 115-146, November.
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