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Does monetary policy have any relationship with the expectations of stock market participants?

Kuo-Che Hung and Tai Ma

Journal of Multinational Financial Management, 2017, vol. 39, issue C, 100-117

Abstract: This study re-examines the effect that price movement expectations of traders in different stock market states have on monetary authorities when deciding monetary policy. We use heterogeneous agent models to estimate the trading strategies of chartists who use expected stock price movements as the basis of their trading strategy. In contrast to the traditional view that monetary policy is not subject to the influence of the stock market, we find that during stock market bubbles (stock market crises), an increase in the fraction of chartists influences subsequent policy decisions to raise (lower) interest rates. This is mainly because monetary authorities are aware of the impact of abnormal stock price volatility on the overall economy. In the year following the occurrence of a bubble (crisis), there were slight decreases (increases) in interest rate levels. However, policymakers’ adjustments of interest rate policy during bull and bear markets may encourage stock price movements.

Keywords: Monetary policy; Stock market expectations; Heterogeneous agent model; Chartists; Stock market bubble; Stock market crisis (search for similar items in EconPapers)
JEL-codes: E52 E58 E03 C33 (search for similar items in EconPapers)
Date: 2017
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DOI: 10.1016/j.mulfin.2016.11.004

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Handle: RePEc:eee:mulfin:v:39:y:2017:i:c:p:100-117