On Monetary Policy and Stock Price Relationship: Long and Short-run Dynamics

Abstract

In this paper, we investigate the relationship between monetary policy and stock prices across advanced and emerging economies from January 1999 to December 2017. We also examine the impact of global monetary policy on the sample stock markets. Using the Structural Cointegrated Vector-Autoregressive model, we explore long-run equilibrium relationship and short-run dynamics of monetary policy and stock markets before and after the global financial crisis. Our results demonstrate that domestic policy rate and stock prices are often not tied together in long-term equilibrium relationships for a majority of the economies. Cross-sectional heterogeneity is observed as the relationship differs in terms of sign, magnitude and adjustment dynamics. Further, US monetary conditions are found to play an important role in influencing global output or liquidity conditions. Short-run dynamics reveal a positive impact of expansionary monetary policy shock on equity prices in those economies where transmission mechanism of monetary policy is weak. Further, we find limited response of central banks to domestic equity price shocks. The influence of US monetary policy shocks in driving equity prices is also found to be insignificant for a majority of the economies.