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Monetary Policy and its Effects on Stock Markets - Research Paper Example

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The research paper "Monetary Policy and its Effects on Stock Markets" states that Catastrophe of 1987 – On October 19, 1987, the stock market along with the associated futures and options market crashed, with the S&P 500 stock market index falling about 20 percent. …
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Extract of sample "Monetary Policy and its Effects on Stock Markets"

Download file to see previous pages During a state of inflation, the purchasing power of money decreases. The effects of inflation are harmful to the economy. Not only does it affect the economy, but also tends to affect the value of stocks, since money loses its value. Higher inflation would tend to depress stock returns because it would raise long-term interest rates (and thereby raise the rate at which investors discount future dividends).

Monetary Policy - Monetary Policy is a means to control inflation, one of the corrective tools of the Central Bank of a country. The presence of inflation in the current market and expected future requires the need for such a policy to ensure that inflation rates do not go above a specific percentage thus acting as a tool to curb inflation.
1. Inflation Targeting – Inflation targeting is a policy that is implemented to keep inflation under a particular range. It targets the Consumer Price Index (CPI) which measures the average price of consumer goods and services purchased by households. A change in the CPI is an indicator of inflation hence inflation targeting aims at maintaining the CPI within a specific range.
2. Price Level Targeting – It is similar to inflation targeting, the only difference is the CPI growth in one year is offset in subsequent years so that over time, the price level on aggregate does not move.

Despite claims that monetary policy should not affect stocks, there is evidence that the policy can affect real stock prices in the short-run (Bernanke & Kuttner 2005) and also an opinion that the nature of the monetary policy regime can affect the performance of asset markets over longer horizons. It has also been observed that by altering the path of expected dividends, the discount rate or the equity premium is one of the effects of the monetary policy on stocks1 Observers of Financial Markets have noted that an unexpected decrease in the federal funds rate target leads to a rapid and positive reaction in stock prices thus implying the effect of the Monetary Policy on Stock Markets.  ...Download file to see next pagesRead More
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