Is the Federal Reserve Bank Stock Market Bubble-Neutral?

Abstract

This paper argues that the Fed was not stock market bubble-neutral during the last several years. This nonneutrality implies two options: first, the Fed has used monetary policies to prevent the building of the stock market bubble or, second, the Fed has contributed to its development and subsequent deflation. We supply representative quotes from the FOMC transcripts to establish that the Fed has paid significant attention to the valuation of the stock market. These quotes confirm that the stock market's valuation was an important variable in the Fed's decision-making and its conduct of monetary policy. We also conduct econometric modeling, by extending the Taylor rule and using data for the 1987-2000 period, to argue that the Fed, perhaps unintentionally, has contributed to the stock market's overvaluation and subsequent decline.

Keywords: Monetary Policy, Federal Reserve Bank, FOMC Transcripts, Stock Market, Bubbles, Taylor's Rule

JEL Classification: E4, E5, G1