Research Discussion Papers, Bank of Finland
No 17/2005:
Identifying the interdependence between US monetary policy and the stock market
Hilde Bjørnland and Kai Leitemo ()
Abstract: We estimate the interdependence between US monetary policy
and the S&P 500 using structural VAR methodology. A solution is proposed to
the simultaneity problem of identifying monetary and stock price shocks by
using a combination of short-run and long-run restrictions that maintains
the qualitative proper-ties of a monetary policy shock found in the
established literature (CEE 1999). We find great interde-pendence between
interest rate setting and stock prices. Stock prices immediately fall by
1.5 per cent due to a monetary policy shock that raises the federal funds
rate by ten basis points. A stock price shock in-creasing stock prices by
one per cent leads to an increase in the interest rate of five basis
points. Stock price shocks are orthogonal to the information set in the VAR
model and can be interpreted as non-fundamental shocks. We attribute a
major part of the surge in stock prices at the end of the 1990s to these
non-fundamental shocks.
Keywords: VAR; monetary policy; asset prices; identification; (follow links to similar papers)
JEL-Codes: E43; E52; E61; (follow links to similar papers)
48 pages, July 11, 2005
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