Working Paper: NBER ID: w14019
Authors: Michael D. Bordo; Michael J. Dueker; David C. Wheelock
Abstract: This paper examines the association between inflation, monetary policy and U.S. stock market conditions during the second half of the 20th century. We estimate a latent variable VAR to examine how macroeconomic and policy shocks affect the condition of the stock market. Further, we examine the contribution of various shocks to market conditions during particular episodes and find evidence that inflation and interest rate shocks had particularly strong impacts on market conditions in the postwar era. Disinflation shocks promoted market booms and inflation shocks contributed to busts. We conclude that central banks can contribute to financial market stability by minimizing unanticipated changes in inflation.
Keywords: Inflation; Monetary Policy; Stock Market; Macroeconomic Shocks
JEL Codes: E31; E52; G12; N12; N22
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| unexpected increase in inflation (E31) | decrease in real stock prices (G19) |
| unexpected increase in inflation (E31) | market conditions shift from boom or normal states toward busts (E32) |
| unexpected decline in inflation (E31) | improved market conditions (R31) |
| unexpected decline in inflation (E31) | stock market boom from 1994 to 2000 (N22) |
| unexpected increases in long-term interest rates (E43) | market towards bust conditions (E32) |
| unexpected declines in long-term interest rates (E43) | support boom conditions (Q33) |
| minimizing unanticipated fluctuations in inflation (E31) | contribute to financial market stability (G18) |