Norges Bank

Working Paper

Identifying the interdependence between US monetary policy and the stock market

by Hilde C. Bjørnland and Kai Leitemo
Working Paper

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