Working Paper presents research work by both Danmarks Nationalbank’s employees and our partners. The series is primarily targeted at professionals and people with an interest in central banking research as well as economics and finance in a broader sense.
Has the Fed Reacted Asymmetrically to Stock Prices?
Yes. Existing studies of the possible role of asset prices in monetary policy implicitly assume that central banks respond to asset price movements in a fully symmetric way. This paper offers a new perspective by allowing for different policy reactions to stock price increases and decreases, respectively. To avoid endogeneity problems, I employ the method of identification through heteroskedasticity. I then demonstrate that the reaction of the Federal Reserve has indeed been asymmetric during the period 1998-2008. While a 5% drop in the S&P 500 index is shown to increase the probability of a 25 basis point interest rate cut by 1/3, no significant reaction to stock price increases can be identified.