Measuring the Reaction of Monetary Policy to the Stock Market

Roberto Rigobon and Brian Sack

No 8350, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: 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.

JEL-codes: E44 E47 (search for similar items in EconPapers)
Date: 2001-07
New Economics Papers: this item is included in nep-fmk and nep-mon
Note: AP IFM ME
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (41)

Published as Rigobon, Robert and Brian Sack. "Measuring The Reaction Of Monetary Policy To The Stock Market," Quarterly Journal of Economics, 2003, v118(2,May), 639-669.

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