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Dichotomous stock market reaction to episodes of rules and discretion in the US monetary policy

Ion-Iulian Marinescu, Alexandra Horobet and Radu Lupu ()

Economic Modelling, 2018, vol. 70, issue C, 56-66

Abstract: We investigate the microeconomic effects of the monetary policy conduct in the United States by observing the response of the domestic capital market with respect to unexpected changes in the Fed Funds rate target in discretionary as opposed to rules-based policy eras. These dichotomous situations are identified by means of a model with structural breaks applied on the deviations of the effective Fed Funds target rate changes from the Taylor (1993) rule implied rate change. Employing an event-study analysis, we measure the response of the S&P500 index to unexpected Fed Funds rate changes, determined from comparison with the futures rates. We find strong evidence which suggests that the monetary policy based on rules spawns consistent rational stock market reactions, while a discretionary policy increases microeconomic uncertainty. We analyze the implications of this dichotomous effect at the level of the risk-taking monetary transmission channel and also provide evidence with respect to the accounts of a monetary policy based on forward rate guidance on the equity market.

Keywords: Monetary policy; Event study; Risk-taking channel; Discretion; Rules; Forward guidance (search for similar items in EconPapers)
JEL-codes: G14 G18 E52 E43 D61 (search for similar items in EconPapers)
Date: 2018
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