Measuring the Reaction of Monetary Policy to the Stock Market / Roberto Rigobon, Brian Sack.

Format:

Book

Author/Creator:

Rigobon, Roberto.

Contributor:

National Bureau of Economic Research.

Sack, Brian.

Series:

Working Paper Series (National Bureau of Economic Research) no. w8350.

NBER working paper series no. w8350

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2001.

Summary:

Movements in the stock market can have a significant impact on the macroeconomy and are therefore likely to be an important factor in the determination of monetary policy. However, little is known about the magnitude of the Federal Reserve's reaction to the stock market. One reason is that it is difficult to estimate the policy reaction because of the simultaneous response of equity prices to interest rate changes. This paper uses an identification technique based on the heteroskedasticity of stock market returns to identify the reaction of monetary policy to the stock market. The results indicate that monetary policy reacts significantly to stock market movements, with a 5% rise (fall) in the S&P 500 index increasing the likelihood of a 25 basis point tightening (easing) by about a half. This reaction is roughly of the magnitude that would be expected from estimates of the impact of stock market movements on aggregate demand. Thus, it appears that the Federal Reserve systematically responds to stock price movements only to the extent warranted by their impact on the macroeconomy.

Notes:

Print version record

July 2001.