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The Fed’s Policy Reaction Function and U.S. Stock Returns

A presentation by
Nikiforos Laopodis
School of Business

When: Monday, December 4, 15:00–15:50

Where: Deree Faculty Lounge

Organized by: Faculty Research Seminars 2017-18 Series

Abstract

This paper examines the dynamic linkages among monetary policy, the stock market and several financial and macroeconomic magnitudes during the monetary regimes of Volcker, Greenspan, Bernanke, and Yellen. The empirical findings from the benchmark federal funds model indicate that there have been distinct reactions of stock returns to fed funds rate shocks during each monetary regime. Specifically, these reactions appear more turbulent and persistent during the Bernanke and Yellen regimes than during the Volcker and Greenspan terms. Thus, it can be concluded that monetary policy has had real and significant (short-run) effects on the stock market under all four monetary regimes examined. When augmenting the Fed’s reaction function with variables such as term and credit spreads, the unemployment rate, and financial uncertainty, it was revealed that the Fed might have actually considered each of these magnitudes separately in its deliberations in setting monetary policy. Finally, upon investigation of the impact of the stock market on various expansions/bull markets and contractions/bear markets it was found that they reacted differently over the different phases of the business cycle. In particular, apart from revealing asymmetric behavior the stock returns’ reactions were found to be dissimilar during each expansion and contraction and bull and bear stock markets or more pronounced during some bear markets than some bull markets.

Keywords: monetary regimes, Fed reaction function, fundamentals, business cycles

Nikiforos T. Laopodis
Department of Accounting and Finance, School of Business
Deree – The American College of Greece
nlaopodis@acg.edu

Annie Triantafyllou
Dean, School of Business and Department of Economics
Deree – The American College of Greece
atriant@acg.edu