Stock Market Bubbles and Monetary Policy Effectiveness
Posted: 18 Apr 2016 Last revised: 1 Dec 2021
Date Written: January 9, 2020
Abstract
In this paper, we provide evidence on the response of stock market returns to monetary policy shocks but condition the analysis on both the direction of monetary policy surprises and business conditions. We follow a two-step approach: First, we use an structural vector autoregressive (SVAR) model to identify a proxy variable of monetary policy shocks; then, we apply a conditional regression to contemporary stock market returns and these monetary policy shocks to extract the implicit relationship between these variables in different scenarios. Our results show that monetary policy does not impact on stock market returns in a significant form in the scenario defined by positive shocks and expansion periods, i.e. the lower effectiveness of restrictive monetary policy shocks coincides with the phase of the business cycle in which bubbles arise.
Keywords: Conditional regressions, structural auto-regressive vector (SVAR), exogenous monetary policy shocks, sign-dependent responses, state-dependent responses
JEL Classification: E43, E44, E52, E58, G12
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