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Identifying the interdependence between US monetary policy and the stock market

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  • Bjørnland, Hilde C.
  • Leitemo, Kai

Abstract

We estimate the interdependence between US monetary policy and the S&P 500 using structural VAR methodology.A solution is proposed to the simultaneity problem of identifying monetary and stock price shocks by using a combination of short-run and long-run restrictions that maintains the qualitative properties of a monetary policy shock found in the established literature (CEE 1999).We find great interdependence between interest rate setting and stock prices.Stock prices immediately fall by 1.5 per cent due to a monetary policy shock that raises the federal funds rate by ten basis points.A stock price shock increasing stock prices by one per cent leads to an increase in the interest rate of five basis points.Stock price shocks are orthogonal to the information set in the VAR model and can be interpreted as non-fundamental shocks.We attribute a major part of the surge in stock prices at the end of the 1990s to these non-fundamental shocks.

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  • Bjørnland, Hilde C. & Leitemo, Kai, 2005. "Identifying the interdependence between US monetary policy and the stock market," Bank of Finland Research Discussion Papers 17/2005, Bank of Finland.
  • Handle: RePEc:zbw:bofrdp:rdp2005_017
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    More about this item

    Keywords

    VAR; monetary policy; asset prices; identification;
    All these keywords.

    JEL classification:

    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects

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