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U.S. Monetary Policy and Stock Prices: Should the Fed Attempt to Control Stock Prices?

John, Tatom (2009): U.S. Monetary Policy and Stock Prices: Should the Fed Attempt to Control Stock Prices?

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Abstract

This article rejects the linkages in proposals that the Federal Reserve Bank (Fed) target equity prices. The real federal funds rate (RFF) and stock prices (SP) are uncorrelated; causality tests show a positive effect of SP on RFF and a negative effect of SP on RFF. These results occur as part of the dynamics of a negative cointegrated relationship between SP and RFF. A theoretically expected inverse relation between SP and inflation accounts for the results. The negative effect of SP on FF is also confirmed in a Taylor Rule estimate. Higher stock prices anticipate lower, not higher, inflation.

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