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Stock Market Uncertainty and Monetary Policy Reaction Functions of the Federal Reserve Bank

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  • Jovanovic Mario

    (Ruhr University Bochum)

  • Zimmermann Tobias

    (RWI Essen)

Abstract

In this paper, we examine the link between stock market uncertainty and monetary policy in the U.S. There are strong arguments as to why central banks should account for stock market uncertainty in their strategies. Amongst others, they can maintain the functioning of financial markets and moderate economic downswings. To describe the behavior of the Federal Reserve Bank, augmented forward-looking Taylor rules are estimated by GMM. The standard specification is expanded by measures of stock market uncertainty. We show that given certain levels of inflation and output, U.S. central bank rates are significantly lower when stock market uncertainty is high and vice versa. This result is valid for all tested measures of financial uncertainty.

Suggested Citation

  • Jovanovic Mario & Zimmermann Tobias, 2010. "Stock Market Uncertainty and Monetary Policy Reaction Functions of the Federal Reserve Bank," The B.E. Journal of Macroeconomics, De Gruyter, vol. 10(1), pages 1-19, July.
    • Handle: RePEc:bpj:bejmac:v:10:y:2010:i:1:n:21
    DOI: 10.2202/1935-1690.2045
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    2. Bachmann, Rüdiger & Born, Benjamin & Elstner, Steffen & Grimme, Christian, 2019. "Time-varying business volatility and the price setting of firms," Journal of Monetary Economics, Elsevier, vol. 101(C), pages 82-99.
    3. Greene, William H. & Gillman, Max & Harris, Mark N. & Spencer, Christopher, 2013. "The Tempered Ordered Probit (TOP) Model with an Application to Monetary Policy," CEI Working Paper Series 2013-04, Center for Economic Institutions, Institute of Economic Research, Hitotsubashi University.
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    5. Mario Jovanovic, 2011. "Does Monetary Policy Affect Stock Market Uncertainty? – Empirical Evidence from the United States," Ruhr Economic Papers 0240, Rheinisch-Westfälisches Institut für Wirtschaftsforschung, Ruhr-Universität Bochum, Universität Dortmund, Universität Duisburg-Essen.
    6. Harold Glenn A. Valera & Mark J. Holmes & Gazi Hassan, 2017. "Stock market uncertainty and interest rate behaviour: a panel GARCH approach," Applied Economics Letters, Taylor & Francis Journals, vol. 24(11), pages 732-735, June.
    7. Jovanović, Mario, 2011. "Does Monetary Policy Affect Stock Market Uncertainty? – Empirical Evidence from the United States," Ruhr Economic Papers 240, RWI - Leibniz-Institut für Wirtschaftsforschung, Ruhr-University Bochum, TU Dortmund University, University of Duisburg-Essen.
    8. Katrin Wölfel & Christoph S. Weber, 2017. "Searching for the Fed’s reaction function," Empirical Economics, Springer, vol. 52(1), pages 191-227, February.
    9. John Nkwoma Inekwe, 2020. "Market uncertainty, risk aversion, and macroeconomic expectations," Empirical Economics, Springer, vol. 59(4), pages 1977-1995, October.
    10. Jukka Sihvonen & Sami Vähämaa, 2014. "Forward‐Looking Monetary Policy Rules and Option‐Implied Interest Rate Expectations," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 34(4), pages 346-373, April.

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