Monetary policy and stock prices
Beckworth, David Michael
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A number of economies at the end of the 20th century were characterized by boom-bust cycles in their stock markets. In most cases, the dramatic growth in stock prices during the boom phase was accompanied by relatively stable growth in output prices. The achievement of stable output prices as a goal for monetary policy is, however, generally regarded as consistent, if not conducive, to equity price stability. How then can there be relatively stable output prices and unstable stock prices? I examine the relationship between monetary policy, output prices, and stock prices by using a simple dynamic general equilibrium model. I find that in periods of increasing aggregate productivity, stabilizing output prices may actually promote stock market boom-bust cycles. Empirically, I check these results and find that during the postwar period monetary policy did systematically accommodate permanent changes in the growth rate of productivity and that this accommodation was associated with some volatility in the real stock price. These results provide consistent but not conclusive evidence for the theoretical findings.