Nonlinearity and Structural Breaks in Monetary Policy Rules with Stock Prices
This paper empirically examines how the Fed responds to stock prices and inflation movements, using the forward-looking Taylor rule augmented with the stock price gap. The typical linear policy reaction function has a substantial change after 1991, but lacks the robustness in that the estimation result is sensitive to a minor change of the sample period. To alleviate the problem, we allow for temporary and permanent variations of the reaction coefficients by introducing nonlinearity and a structural break. The time variation of the inflation coefficient shows that the Fed is more aggressive in periods of inflationary pressure. However, unlike the linear model case, we find little evidence of a significant change in the Fed's active response to inflationary pressure after the structural break at 1991:I. We also find a positive response to the stock price change after 1991:I. But the time varying pattern of the response is counter-cyclical to stock price change, which does not support the view that the Fed actively reacts to a stock price bubble.
|Date of creation:||Oct 2011|
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- Roberto Rigobon & Brian Sack, 2003. "Measuring The Reaction of Monetary Policy to the Stock Market," The Quarterly Journal of Economics, Oxford University Press, vol. 118(2), pages 639-669.
- M. D. Hayford & A. G. Malliaris, 2005.
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World Scientific Book Chapters,in: Economic Uncertainty, Instabilities And Asset Bubbles Selected Essays, chapter 14, pages 223-232
World Scientific Publishing Co. Pte. Ltd..
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- Hilde C. Bjørnland & Kai Leitemo, 2008. "Identifying the interdependence between US monetary policy and the stock market," Working Paper 2008/04, Norges Bank.
- Bjørnland, Hilde C. & Leitemo, Kai, 2005. "Identifying the interdependence between US monetary policy and the stock market," Research Discussion Papers 17/2005, Bank of Finland.
- J. Jouini & M. Boutahar, 2003. "Structural breaks in the U.S. inflation process: a further investigation," Applied Economics Letters, Taylor & Francis Journals, vol. 10(15), pages 985-988.
- Bill Dupor & Timothy Conley, 2004. "The Fed Response to Equity Prices and Inflation," American Economic Review, American Economic Association, vol. 94(2), pages 24-28, May.
- Mohamed Safouane Ben Aissa & Jamel Jouini, 2003. "Structural breaks in the US inflation process," Applied Economics Letters, Taylor & Francis Journals, vol. 10(10), pages 633-636.
- Botzen, W.J. Wouter & Marey, Philip S., 2010. "Did the ECB respond to the stock market before the crisis?," Journal of Policy Modeling, Elsevier, vol. 32(3), pages 303-322, May. Full references (including those not matched with items on IDEAS)
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