Norges Bank

Working Paper

Identifying the interdependence between US monetary policy and the stock market

Author:
by Hilde C. Bjørnland and Kai Leitemo
Series:
Working Paper
Number:
4/2008

We estimate the interdependence between US monetary policy and the S&P 500 using structural VAR methodology. A solution is proposed to the simultaneity problem of identifying monetary and stock price shocks by using a combination of short-run and long-run restrictions that maintains the qualitative properties of a monetary policy shock found in the established literature (Christiano et al., 1999). We find great interdependence between interest rate setting and real stock prices. Real stock prices immediately fall by 7-9 percent due to a monetary policy shock that raises the federal funds rate by 100 basis points. A stock price shock increasing real stock prices by one percent leads to an increase in the interest rate of close to 4 basis points.

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ISSN 1502-8190 (online)

Published 10 April 2008 14:00
Published 10 April 2008 14:00