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

Mario Jovanovic 1 , 1  and Tobias Zimmermann 2 , 2
  • 1 Ruhr University Bochum, mario.jovanovic@ruhr-uni-bochum.de
  • 2 RWI Essen, tobias.zimmermann-4@rub.de

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.

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The B.E. Journal of Macroeconomics publishes significant research and scholarship in theoretical and applied macroeconomics. The range of topics includes business cycle research, economic growth, and monetary economics, as well as topics drawn from the substantial areas of overlap between macroeconomics and international economics, labor economics, finance, development economics, political economy, public economics, econometric theory.

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