DP10070 | The Effects of Monetary Policy on Stock Market Bubbles: Some Evidence

Publication Date

20/07/2014

JEL Code(s)

Keyword(s)

Programme Area(s)

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.