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The effects of monetary policy on stock market bubbles: Some evidence

We estimate the response of stock prices to exogenous monetary policy shocks using a vector-autoregressive model with time-varying parameters. Our evidence points to protracted episodes in which, after a a short-run decline, stock prices increase persistently in response to an exogenous tightening of monetary policy. That response is clearly at odds with the "conventional" view on the effects of monetary policy on bubbles, as well as with the predictions of bubbleless models. We also argue that it is unlikely that such evidence be accounted for by an endogenous response of the equity premium to the monetary policy shocks.

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Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 1392.

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Date of creation: Oct 2013
Date of revision: Dec 2013
Handle: RePEc:upf:upfgen:1392
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  1. Refet Gürkaynak & Brian Sack, 2005. "Do Actions Speak Louder Than Words?The Response of Asset Prices to Monetary Policy Actions and Statements," Computing in Economics and Finance 2005 323, Society for Computational Economics.
  2. Thorbecke, Willem, 1997. " On Stock Market Returns and Monetary Policy," Journal of Finance, American Finance Association, vol. 52(2), pages 635-54, June.
  3. 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.
  4. 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, 06.
  5. Luca Gambetti & Jordi Galí, 2007. "On the sources of the Great Moderation," Proceedings, Federal Reserve Bank of San Francisco, issue Nov.
  6. Manuel S. Santos & Michael Woodford, 1997. "Rational Asset Pricing Bubbles," Econometrica, Econometric Society, vol. 65(1), pages 19-58, January.
  7. D’Amico, Stefania & Farka, Mira, 2011. "The Fed and the Stock Market: An Identification Based on Intraday Futures Data," Journal of Business & Economic Statistics, American Statistical Association, vol. 29(1), pages 126-137.
  8. Roberto Rigobon & Brian Sack, 2003. "Measuring The Reaction Of Monetary Policy To The Stock Market," The Quarterly Journal of Economics, MIT Press, vol. 118(2), pages 639-669, May.
  9. Jeff Fuhrer & Geoff Tootell, 2004. "Eyes on the prize: how did the Fed respond to the stock market?," Public Policy Discussion Paper 04-2, Federal Reserve Bank of Boston.
  10. Tirole, Jean, 1985. "Asset Bubbles and Overlapping Generations," Econometrica, Econometric Society, vol. 53(6), pages 1499-1528, November.
  11. Patelis, Alex D, 1997. " Stock Return Predictability and the Role of Monetary Policy," Journal of Finance, American Finance Association, vol. 52(5), pages 1951-72, December.
  12. Ben S. Bernanke & Mark Gertler, 2001. "Should Central Banks Respond to Movements in Asset Prices?," American Economic Review, American Economic Association, vol. 91(2), pages 253-257, May.
  13. 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.
  14. Paul A. Samuelson, 1958. "An Exact Consumption-Loan Model of Interest with or without the Social Contrivance of Money," Journal of Political Economy, University of Chicago Press, vol. 66, pages 467.
  15. Philip Lowe & Claudio Borio, 2002. "Asset prices, financial and monetary stability: exploring the nexus," BIS Working Papers 114, Bank for International Settlements.
  16. Jordi Gal?, 2014. "Monetary Policy and Rational Asset Price Bubbles," American Economic Review, American Economic Association, vol. 104(3), pages 721-52, March.
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