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The Fed and the Stock Market

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Listed:
  • Paolo Surico
  • Antonello D'Agostino
  • Luca Sala

Abstract

The Fed closely monitors the stock market and the stock market continuously forms expectations about the Fed decisions. What does this imply for the relation between the fed funds rate and the S&P500? We find that the answer depends on the conditions prevailing on the financial market. During periods of high (low) volatility in asset price inflation an unexpected 5 fall in the stock market index implies that the Fed cuts the interest rate by 19 ($6$) basis points while an unanticipated policy tightening of 50 basis points causes a 4.7 (2.3) decline in the S&P500. The Fed reaction to asset price return is however statistically different from zero only in the high volatility regime, whereas the fall in asset price return following an interest rate rise is highly significant during normal times only

Suggested Citation

  • Paolo Surico & Antonello D'Agostino & Luca Sala, 2005. "The Fed and the Stock Market," Computing in Economics and Finance 2005 293, Society for Computational Economics.
  • Handle: RePEc:sce:scecf5:293
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    References listed on IDEAS

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    1. Ben S. Bernanke & Kenneth N. Kuttner, 2005. "What Explains the Stock Market's Reaction to Federal Reserve Policy?," Journal of Finance, American Finance Association, vol. 60(3), pages 1221-1257, June.
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    4. Michael D. Bordo & Olivier Jeanne, 2002. "Boom-Busts in Asset Prices, Economic Instability, and Monetary Policy," NBER Working Papers 8966, National Bureau of Economic Research, Inc.
    5. Ben S. Bernanke & Mark Gertler, 1999. "Monetary policy and asset price volatility," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 77-128.
    6. Rigobon, Roberto & Sack, Brian, 2004. "The impact of monetary policy on asset prices," Journal of Monetary Economics, Elsevier, vol. 51(8), pages 1553-1575, November.
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    Cited by:

    1. Cinzia Alcidi , Alessandro Flamini, Andrea Fracasso, 2005. ""Taylored rules". Does one fit (or hide) all?," IHEID Working Papers 04-2005, Economics Section, The Graduate Institute of International Studies, revised Apr 2006.
    2. Ravn Søren Hove, 2012. "Has the Fed Reacted Asymmetrically to Stock Prices?," The B.E. Journal of Macroeconomics, De Gruyter, vol. 12(1), pages 1-36, June.
    3. Nan-Kuang Chen & Han-Liang Cheng & Hsiao-Lei Chu, 2015. "Asset price and monetary policy: the effect of expectations formation," Oxford Economic Papers, Oxford University Press, vol. 67(2), pages 380-405.
    4. Daria Finocchiaro & Virginia Queijo Heideken, 2013. "Do Central Banks React to House Prices?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 45(8), pages 1659-1683, December.
    5. repec:taf:apeclt:v:24:y:2017:i:11:p:732-735 is not listed on IDEAS
    6. Cinzia Alcidi & Alessandro Flamini & Andrea Fracasso, 2011. "Policy Regime Changes, Judgment and Taylor rules in the Greenspan Era," Economica, London School of Economics and Political Science, vol. 78(309), pages 89-107, January.
    7. Jovanovic Mario & Zimmermann Tobias, 2010. "Stock Market Uncertainty and Monetary Policy Reaction Functions of the Federal Reserve Bank," The B.E. Journal of Macroeconomics, De Gruyter, vol. 10(1), pages 1-19, July.
    8. Castelnuovo, Efrem & Nisticò, Salvatore, 2010. "Stock market conditions and monetary policy in a DSGE model for the U.S," Journal of Economic Dynamics and Control, Elsevier, vol. 34(9), pages 1700-1731, September.
    9. Mandler, Martin, 2009. "In search of robust monetary policy rules - Should the Fed look at money growth or stock market performance?," Journal of Macroeconomics, Elsevier, vol. 31(2), pages 345-361, June.
    10. Francesco Furlanetto, 2011. "Does Monetary Policy React to Asset Prices? Some International Evidence," International Journal of Central Banking, International Journal of Central Banking, vol. 7(3), pages 91-111, September.
    11. Castelnuovo, Efrem, 2013. "Monetary policy shocks and financial conditions: A Monte Carlo experiment," Journal of International Money and Finance, Elsevier, vol. 32(C), pages 282-303.
    12. Mandler, Martin, 2006. "Are there gains from including monetary aggregates and stock market indices in the monetary policy reaction function? A simulation study of recent U.S. monetary policy," MPRA Paper 2318, University Library of Munich, Germany.
    13. Marie-Louise Djigbenou, 2014. "Determinants of Global Liquidity Dynamics:a FAVAR approach," Working Papers hal-00956314, HAL.

    More about this item

    Keywords

    asset price volatility; nonlinear policy; threshold SVAR; system GMM.;

    JEL classification:

    • 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
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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