Economic uncertainty and the influence of monetary policy

This paper explores if economic uncertainty alters the macroeconomic influence of monetary policy. We use several measures of U.S. economic uncertainty, and estimate their interaction with monetary policy shocks as identified through structural vector autoregressions. We find that U.S. monetary policy shocks affect economic activity less when uncertainty is high, in line with “real-option” effects from theory. Holding uncertainty constant, the effect on investment is approximately halved when uncertainty is in its top instead of its bottom decile.     

Risk,uncertainty and monetary policy

The VIX, the stock market option-based implied volatility, strongly co-moves with measures of the monetary policy stance. When decomposing the VIX into two components, a proxy for risk aversion and expected stock market volatility (“uncertainty”), we find that a lax monetary policy decreases both risk aversion and uncertainty, with the former effect being stronger. The result holds in a structural vector autoregressive framework, controlling for business cycle movements and using a variety of identification schemes for the vector autoregression in general and monetary policy shocks in particular. The effect of monetary policy on risk aversion is also apparent in regressions using high frequency data.     

Unconventional monetary policy had large international effects

The Federal Reserve’s unconventional monetary policy announcements in 2008–2009 substantially reduced international long-term bond yields and the spot value of the dollar. These changes closely followed announcements and were very unlikely to have occurred by chance. A simple portfolio choice model can produce quantitatively plausible changes in U.S. and foreign excess bond yields. The jump depreciations of the USD are fairly consistent with estimates of the impacts of previous equivalent monetary policy shocks. The policy announcements do not appear to have reduced yields by reducing expectations of real growth. Unconventional policy can reduce international long-term yields and the value of the dollar even at the zero bound.     

The impact of monetary policy announcements on the stock price of large European banks during the financial crisis

Since 2007, the European Central Bank responded decisively to the challenges posed by the global financial crisis, reducing key policy interest rates to unprecedented low levels and intervening with non-standard policy measures (i.e., monetary easing and liquidity provision). This paper aims to assess the impact of ECB monetary policy announcements on the stock price of large European banks. As a first step, an event study is conducted in order to measure cumulated abnormal returns (CARs) around the announcements over June 2007–June 2013; the second step is a regression analysis aimed at identifying the determinants of CARs. Results show that banks were more sensitive to non-conventional measures than to interest rate decisions, and that the same type of intervention may have a different impact depending on the stage of the crisis. In addition, banks with weaker balance sheets and operating with high-risk were more sensitive to monetary policy interventions.     

Market reactions to ECB policy innovations: A cross-country analysis

Regulators have been paying increasing attention to governing and steering market fluctuations, with their role in shaping the economic cycle being ever more crucial. The combined effect of the financial and sovereign debt crises, as well as the approach to the zero lower bound, has made actions even more pressing, forcing the European Central Bank to resort to unconventional instruments to revive the economies and counter deflationary pressures. By using a combined event study and panel regression methodology, we investigate whether European Monetary Union equity markets react heterogeneously to standard and non-standard European Central Bank policy innovations. Our results show that conventional policies unevenly affect financial indices in the Eurozone and, hence, are bound to generate asymmetries that reflect on real economies, while unconventional measures, albeit with different intensities, exercise a homogeneous pressure on all markets. Our evidence highlights the beneficial impact of unconventional measures and suggests that they can play a useful role even in non-crisis times.     

Labor market participation,unemployment and monetary policy

Models of unemployment and monetary policy usually assume constant participation. Incorporating a participation decision into a standard New Keynesian model with matching frictions, we show that market tightness becomes endogenously more volatile because both the opportunity cost of home production and the reservation wage vary with participation. The model can simultaneously explain the low volatility of participation, the high volatility of unemployment, and a procyclical workers׳ outside option of working. A policy of strict inflation targeting is close to optimal, and increasing the response of the interest rate to inflation does not have a large impact on the volatility of unemployment because of the endogenous response of participation.     

Macroeconomic cycles and the stock market’s reaction to monetary policy

This paper examines cyclical variation in the effect of Fed policy on the stock market. We find a much stronger response of stock returns to unexpected changes in the federal funds target rate in recession and in tight credit market conditions. Using firm-level data, we also show that firms that face financial constraints are more affected by monetary shocks in tight credit conditions than the relatively unconstrained firms. Overall, the results are consistent with the credit channel of monetary policy transmission.     

The impact of monetary policy surprises on asset return volatility: the case of Germany

This paper investigates the impact of monetary policy surprises by the FED or Bundesbank/ECB on the return volatility of German stocks and bonds using a GARCH-M model. We show that stock return volatility is susceptible to monetary policy surprises in the United States, whereas monetary policy surprises in the Euro zone matter for bond return volatility. These findings are robust for other Euro zone stock markets, but not significant for other Euro zone bond markets. The empirical evidence also suggests that monetary policy surprises have larger effects on German stock return volatility in bear markets than in bull phases. Moreover, our results support the claim that stock return volatility can be negatively correlated with stock returns, contradicting predictions made by many asset pricing models (e.g., CAPM or ICAPM) and the empirical finding of an insignificant relationship often reported in the literature.

Nominal rigidities,asset returns,and monetary policy

Asset-return implications of nominal price and wage rigidities are analyzed in general equilibrium. Nominal rigidities, combined with permanent productivity shocks, increase expected excess returns on production claims. This is mainly explained by consumption dynamics driven by rigidity-induced changes in employment and markups. An interest-rate monetary policy rule affects asset returns. Stronger (weaker) rule responses to inflation (output) increase expected excess returns. Policy shocks substantially increase asset-return volatility. Price rigidity heterogeneity produces cross-sectoral differences in expected returns. The model matches important macroeconomic moments and the Sharpe ratio of stock returns, but only captures a small fraction of the observed equity premium.     

The impact of monetary policy on the exchange rate: A high frequency exchange rate puzzle in emerging economies

This study investigates the impact of monetary policy shocks on the exchange rates of Brazil, Mexico and Chile. We find that even a focus on 1 day exchange rate changes following policy events – which reduces the potential for reverse causality considerably – fails to lend support for the view that associates unexpected interest rate hikes with immediate appreciations. This lack of empirical backing for the predictions of standard open economy models persists irrespective of whether we use the US Dollar or effective exchange rates, whether changes in the policy rate that were followed by exchange rate interventions are excluded, whether “contaminated” events are dropped from the analysis or whether we allow for non-linearities. We argue that it is difficult to attribute this stronger version of the exchange rate puzzle to fiscal dominance, as unexpected rate increases are not associated with increases in risk premia, and similar results are obtained in the case of Chile – a country that has had the highest possible short-term credit rating since 1995 and a debt/GDP ratio below 10%.     

The Greenspan years: an analysis of the magnitude and speed of the equity market response to FOMC announcements

We examine the impact of monetary policy on the S&P 500 using intraday data. The analysis shows an economically and statistically significant relationship between S&P 500 intraday returns and changes in the Fed funds target rate. The significance and magnitude of the response is dependent on whether the change was expected or unexpected. An expected change in the Fed funds target rate has no impact on prices in the broad equity market; however, an unexpected change of 25 basis points in the Fed funds target rate results in an approximate 48 basis points decline in the broad equity market’s return. The speed of these market reactions is rapid with the equity market reaching a new equilibrium within 15 minutes.

Narrative and VAR approaches to monetary policy: Common identification problems

Romer and Romer [Romer, C.D., Romer, D.H. 1989. Does monetary policy matter? A new test in the spirit of Friedman and Schwartz. In: Blanchard, O.J., Fischer, S. (Eds.), NBER Macroeconomics Annual 1989. MIT Press, Cambridge, MA, pp. 121–170; Romer, C.D., Romer, D.H., 1994. Monetary policy matters. Journal of Monetary Economics 34, 75–88] adopted a narrative approach to address the identification problems in time series models of monetary policy. Based on Federal Reserve documents, the Romers created a dummy variable equal to one in periods when the Federal Reserve contracted in response to perceived inflationary pressures. This paper shows: (1) the dummy variable is predictable from past macroeconomic variables, reflecting the endogenous response of policy to the economy; (2) unpredictable changes in the dummy do not generate dynamic responses that look like the effects of monetary policy. The identification problems that plague time series models also afflict the narrative approach.     

股票价格、货币政策和宏观经济波动

本文对包含股票价格在内的新凯恩斯模型的结构方程进行估计,分析了股票价格和货币政策与宏观经济波动之间的关系,认为股票价格与宏观经济波动密切相连,货币政策调整可以平滑经济波动。在此基础上,比较了不同的货币政策规则的宏观调控效果,得到的结论是,将股票价格波动纳入货币政策的调控范围会改善货币政策效果,有助于稳定宏观经济。     

Futures prices as risk-adjusted forecasts of monetary policy

Many researchers have used federal funds futures rates as measures of financial markets’ expectations of future monetary policy. However, to the extent that federal funds futures reflect risk premia, these measures require some adjustment. In this paper, we document that excess returns on federal funds futures have been positive on average and strongly countercyclical. In particular, excess returns are surprisingly well predicted by macroeconomic indicators such as employment growth and financial business-cycle indicators such as Treasury yield spreads and corporate bond spreads. Excess returns on eurodollar futures display similar patterns. We document that simply ignoring these risk premia significantly biases forecasts of the future path of monetary policy. We also show that risk premia matter for some futures-based measures of monetary policy shocks used in the literature.     

Search and matching frictions and optimal monetary policy

A recent literature has merged the New Keynesian and the search and matching frameworks, which has allowed the former to analyze the joint dynamics of unemployment and inflation. This paper analyzes optimal monetary policy in this kind of hybrid framework. I show that zero inflation is optimal when all wages are Nash bargained in every period and the economy's steady state is efficient. In the more realistic case in which nominal wage bargaining is staggered, a case against price stability arises: in response to real shocks, the central bank should use price inflation so as to avoid excessive unemployment volatility and excessive dispersion in hiring rates. For a plausible calibration, the welfare loss under the zero inflation policy is about three times as large as under the optimal policy.     

Stock market reaction to policy interventions

ABSTRACT

We analyse stock price reactions to the announcements of monetary and fiscal policy actions in 12 stock exchanges worldwide between 1 June 2007 and 30 June 2012. While past papers have analysed the effect of policy interventions focusing on monetary policy actions (e.g. Ricci 2015), our paper focuses on stock indices either capturing the whole stock market or various industries. By estimating abnormal stock reactions around the announcement date, we show that (1) stock industry indices react to policy interventions in a different manner than the broad stock index does; (2) stock returns react negatively to restriction measures for general and non-banking sector indices; and (3) stock reaction to expansionary measures was stronger at the beginning of the financial crisis.     

The impact of conventional and unconventional monetary policy on investor sentiment

This paper examines the relationship between monetary policy and investor sentiment across conventional and unconventional monetary policy regimes. During conventional times, we find that a surprise decrease in the fed funds rate leads to a large increase in investor sentiment. Similarly, when the fed funds rate is at its zero lower bound, research results indicate that expansionary unconventional monetary policy shocks also have a large and positive impact on investor mood. Together, our findings highlight the importance of both conventional and unconventional monetary policy in the determination of investor sentiment.     

Economic costs of alternative monetary policy responses to speculative currency attacks

The outcome of a speculative attack on the foreign exchange rate can be classified into three cases: (i) immediate depreciation of the nominal exchange rate, (ii) successful defense, or (iii) failed defense. This paper explores which of these outcomes yields the lowest cost in terms of output and unemployment in the short and medium run. Ex-ante the outcome of a speculative attack is uncertain, therefore the appropriate response of monetary authorities to a speculative attack depends on the cost of an immediate depreciation compared with that of the expected outcome of a currency defense. Our empirical analysis focuses on a sample of 73 emerging and developing countries over the 1960–2011 period. Our results indicate that an immediate depreciation is the policy response that is associated with a lower expected output loss and unemployment in the short run and it tends to be expansionary in the medium run. A defense, if successful, entails insignificant costs in the short run but, unlike an immediate depreciation, a successful defense is not expansionary in the medium run. If a defense fails, large output losses and an increase in unemployment ensue, at least in the short run.     

Stock price reactions to earnings announcements: evidence from Chinese markets

We examine the stock price reactions to changes in earnings per share (EPS) in the Chinese stock markets. We find that domestic A-share investors do not correctly anticipate the changes in earnings and fail to adjust new earnngs information quickly, but international B-share investors can predict earnings changes better than A-share investors. As a result, abnormal returns (ARs) can be obtained by trading on the earnings information, but for A shares only. An explanation is that most A-share holders are individuals with short-term investment horizon while most B-share holders are large institutions that trade on more detailed and accurate financial information not immediately available to A-share holders.