Monetary Policy & Stock Market

TL;DR

This paper investigates the relationship between monetary policy, asset price volatility, and economic indicators in the US and UK from 1990 to 2020, using Taylor rule-based models and empirical tests.

Contribution

It introduces an augmented Taylor rule incorporating asset prices and compares monetary policy effectiveness between the US and UK.

Findings

Asset prices influence monetary policy decisions.

Model stability varies over time and shocks.

US and UK policies are differently explained by Taylor rule.

Abstract

This paper assesses the link between central bank's policy rate, inflation rate and output gap through Taylor rule equation in both United States and United Kingdom from 1990 to 2020. Also, it analyses the relationship between monetary policy and asset price volatility using an augmented Taylor rule. According to the literature, there has been a discussion about the utility of using asset prices to evaluate central bank monetary policy decisions. First, I derive the equation coefficients and examine the stability of the relationship over the shocking period. Test the model with actual data to see its robustness. I add asset price to the equation in the next step, and then test the relationship by Normality, Newey-West, and GMM estimator tests. Lastly, I conduct comparison between USA and UK results to find out which country's policy decisions can be explained better through Taylor rule.