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The Fed and the Stock Market

  • Antonello D'Agostino

    (ECARES, Universite' Libre de Bruxelles & European Central Bank)

  • Luca Sala

    (IGIER, Bocconi University)

  • Paolo Surico

    (Bank of England & University of Bari)

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.

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File URL: http://128.118.178.162/eps/mac/papers/0507/0507001.pdf
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Paper provided by EconWPA in its series Macroeconomics with number 0507001.

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Length: 21 pages
Date of creation: 04 Jul 2005
Date of revision:
Handle: RePEc:wpa:wuwpma:0507001
Note: Type of Document - pdf; pages: 21
Contact details of provider: Web page: http://128.118.178.162

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  1. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March.
  2. Bordo, Michael D & Jeanne, Olivier, 2002. "Boom-Busts in Asset Prices, Economic Instability and Monetary Policy," CEPR Discussion Papers 3398, C.E.P.R. Discussion Papers.
  3. 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.
  4. 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.
  5. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1998. "Monetary Policy Shocks: What Have We Learned and to What End?," NBER Working Papers 6400, National Bureau of Economic Research, Inc.
  6. Bernanke, B. & Gertler, M. & Gilchrist, S., 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," Working Papers 98-03, C.V. Starr Center for Applied Economics, New York University.
  7. Ben Bernanke & Mark Gertler, 1999. "Monetary policy and asset price volatility," Economic Review, Federal Reserve Bank of Kansas City, issue Q IV, pages 17-51.
  8. Roberto Rigobon & Brian P. Sack, 2002. "The Impact of Monetary Policy on Asset Prices," NBER Working Papers 8794, National Bureau of Economic Research, Inc.
  9. Jagjit S. Chadha & Lucio Sarno & Giorgio Valente, 2004. "Monetary Policy Rules, Asset Prices, and Exchange Rates," IMF Staff Papers, Palgrave Macmillan, vol. 51(3), pages 529-552, November.
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