Measuring The Reaction of Monetary Policy to the Stock Market

By Roberto Rigobon, Brian P. Sack. 2003

823 citations recorded by the source corpus.

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.

Subfields: Economics and Econometrics, Finance

View Paper: https://www.semanticscholar.org/paper/7b318dc938df8bff614f56c89cb71ea0bdf54ddd

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Citations in the corpus

Stock Market Reaction to Fed Funds Rate Surprises: State Dependence and the Financial Crisis (2013, result): “As noted in previous research, endogeneity may impose potential econometric problems since monetary policy can be itself reacting to stock market developments (see Rigobon and Sack, 2003).”
Risk, Uncertainty and Monetary Policy (2013, neutral): “In fact, Rigobon and Sack (2003) find that the Federal Reserve does systematically respond to stock prices.3 Second, the relationship between risk aversion and monetary policy may also reflect the joint response to an omitted variable, with business cycle variation being a prime candidate.”
Using monetary policy to stabilize economic activity (2009, background): “Rigobon and Sack 2003 find that 22 This describes optimal commitment policy from the timeless perspective. the Federal Reserve has reacted to stock market prices.”
Once Again, is Openness Good for Growth? (2004, neutral): “Applications where the heteroskedasticity is described by regimes shifts are Rigobon (2002b 2003b), Rigobon and Sack (2003b) , Caporale et. al. (2002b).”
Taking Stock: Monetary Policy Transmission to Equity Markets (2004, background): “Similar to Bernanke and Kuttner (2003), this empirical measure avoids the pitfalls of endogeneity and lack of identification, as outlined by Rigobon and Sack (2002, 2003), by instead developing and employing a truly exogenous measure of monetary policy shocks.”
Global Financial Transmission of Monetary Policy Shocks (2009, neutral): “…for instance for domestic US markets it has been shown that although the transmission of US short-term interest rate changes is highly important for US equity returns, there is at times also a transmission in the opposite direction from equity markets to money markets (Rigobon and Sack 2003).”
The macroeconomic effects of fiscal policy (2012, neutral): “Rigobon and Sack (2002, 2003) and Craine and Martin (2003) use a heteroscedasticitybased estimator and find a significant response of the stock market to shocks in the interest.”
FISCAL POLICY AND ASSET PRICES (2013, neutral): “2For the e¤ects of monetary policy on stock prices and/or stock returns, see, for instance, Rigobon and Sack (2003), Bernanke and Kuttner (2005), Bordo and Wheelock (2007), and Wongswan (2009).”
Stock market response to monetary and fiscal policy shocks: Multi-country evidence (2013, background): “In a similar fashion, Ehrmann and Fratzscher (2004), Rigobon and Sack (2003), and more recently, Sousa (2010) provide evidence that there is a negative relationship between contractionary monetary policy and stock market performance.”
A unified measure of Fed monetary policy shocks (2019, methodology): “Therefore, although this step could be done using OLS and high-frequency FOMC announce- ment day data, we instead use the heteroskedasticity-based estimator of Rigobon (2003) and Rigobon and Sack (2003, 2004).”