Working Paper: CEPR ID: DP10070
Authors: Jordi Gal; Luca Gambetti
Abstract: We estimate the response of stock prices to exogenous monetary policy shocks using a vector-autoregressive model with time-varying parameters. Our evidence points to protracted episodes in which stock prices end up increasing persistently in response to an exogenous tightening of monetary policy, even though they experience a small decline in the short run. That response is clearly at odds with the "conventional" view on the effects of monetary policy on bubbles, as well as with the predictions of bubbleless models. We also argue that it is unlikely that such evidence be accounted for by an endogenous response of the equity premium to the monetary policy shocks.
Keywords: Asset Price Booms; Financial Stability; Inflation Targeting; Leaning Against the Wind Policies
JEL Codes: E52; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Monetary policy shocks (E39) | Stock prices (G19) |
| Exogenous tightening of monetary policy (E52) | Stock prices (G19) |
| Relative size of the bubble component (Y10) | Response of stock prices (G17) |
| Interest rate hike (E43) | Bubble component of stock prices (E32) |