Monetary Policy and the Stock Market - Essay Example

Many papers have found that the extent to which monetary policymakers react to stock market changes are often driven by other factors such as the rate of inflation and output gap. In most of the cases, stock market changes are rarely the aspects which influence monetary policy. The present paper attempts to examine this very fact through employing least square methods. In order to assess this relation, Taylor’s rule has been modified accordingly. The output however, yielded does not depict a highly significant association between stock market fluctuations and the dependent variable, monetary policies which is duplicated by Federal Funds Rate.

1 - Introduction Stock market fluctuations often decide the financial state of an economy. These, in turn, could act as the decisive forces behind the monetary policy framework of an economy. Movements adapted by stock market indices often reflect the behaviour patterns exhibited by many essential economic variables. Stock market indices might be regarded as a mirror image of the way their components behave over time. In case that these components exhibit an average upward trend, the implication is that of a rising stock price index, while they display a downward trend implies the stock prices moving down on an average.

Movements of stock prices often indicate the extent to which an economy is soaring. High figures of stock price indices in an economy indicate upward inflationary trends in the economy. Hence, it is important to keep a note of the fluctuations that the stock market indices depict. Inflationary pressures are rather regarded as harmful for the economy and hence they often are kept under control by the monetary policymakers of an economy. Thus, it can be argued. Stock market fluctuations often decide the financial state of an economy.

These, in turn, could act as the decisive forces behind the monetary policy framework of an economy. Movements adapted by stock market indices often reflect the behaviour patterns exhibited by many essential economic variables. Stock market indices might be regarded as a mirror image of the way their components behave over time. In case that these components exhibit an average upward trend, the implication is that of a rising stock price index, while they display a downward trend implies the stock prices moving down on an average.

Movements of stock prices often indicate the extent to which an economy is soaring. High figures of stock price indices in an economy indicate upward inflationary trends in the economy. Hence, it is important to keep a note of the fluctuations that the stock market indices depict. Inflationary pressures are rather regarded as harmful for the economy and hence they often are kept under control by the monetary policymakers of an economy. Thus, it can be argued that higher the stock market index of a nation , greater will be the inflationary pressure upon the economy.

This tempts the monetary policymakers to frame strategies for regulation of the same. This inflationary pressure could actually lead to a rise in the velocity of money .This , in turn, could actually result to higher economic activities and at the same time leads to price hikes. These price hikes might lead to depreciation in the rate of exchange and thus eventually reduce the inflow of foreign direct investments. This is because overseas investors are no longer allured by the thought of earning higher amounts in repayment.