Monetary Rules and Stock Market Value

Motivated by the difficulties of successfully operating a discretionary monetary policy, researchers and policymakers have become increasingly interested in the stabilization properties of a credible precommitment or rule on monetary policy. The theoretical and empirical effects of various monetary rules on real sector variables, such as employment and GNP, have been extensively studied [e.g., Bean (1983); Fischer (1991); Frankel and Chinn (1995)], but their impact on financial markets (and, therefore, aggregate wealth) has received little attention. This is surprising, given the importance of monetary factors for financial markets as documented by, among others, Bailey (1988), Friedman (1988) and Roley (1987). Recent papers by Svensson (1989) and Boyle and Peterson (1995) have incorporated monetary policy into standard models of asset trade and pricing. In a two-period world, Svensson (1989) identified specific monetary policy rules, and demonstrated that these have significant effects on interest rate risk and the pattern of international trade, but did not examine the implications of these rules for equity values. In an infinite-horizon model, Boyle and Peterson (1995) generalized the monetary policy framework used by Svensson (1989) to allow for imperfect implementation of the chosen policy, but did not address the stock market implications of specific monetary policy targets.