The ultimate objectives of monetary policy are expressed in terms of macroeconomic variables such as output, employment, and inflation. However, the influence of monetary policy instruments on these variables is at best indirect.
The most direct and immediate effects of monetary policy actions, such as changes in the federal funds rate, are on the financial markets; by affecting asset prices and returns, policymakers try to modify economic behavior in ways that will help to achieve their ultimate objectives. Understanding the links between monetary policy and asset prices is thus crucially important for understanding the policy transmission mechanism.
This paper is an empirical study of the relationship between monetary policy and one of the most important financial markets, the market for equities. According to the conventional wisdom, changes in monetary policy are transmitted through the stock market via changes in the values of private portfolios (the “wealth effect”), changes in the cost of capital, and by other mechanisms as well.
Some observers also view the stock market as an independent source of macroeconomic volatility, to which policymakers may wish to respond. For these reasons, it will be useful to obtain quantitative estimates of the links between monetary policy changes and stock prices. In this paper we have two principal objectives. First, we measure and analyze in some detail the stock market’s response to monetary policy actions, both in the aggregate and at the level of industry portfolios. Second, we try to gain some insights into the reasons for the stock market’s response.
Download
PDF Ebook What Explains the Stock Market’s Reaction to Federal Reserve Policy?
