The Time Varying Effect of Monetary Policy Surprise on Stock Returns: Bursting Bubble Beating Forward Guidance

perc.tamu.edu 1 hen the economy expands too quickly, the Federal Reserve may take steps to slow economic growth by raising short-term interest rates or selling Treasury bonds. Such measures, known as tight monetary policy, reduce the demand for money and curb inflation. However, if restrictive monetary policy actions are unanticipated, they may induce an asset shift from stocks to credit instruments, and stock prices may fall. In PERC Working Paper 1505, Dennis W. Jansen, Jordan Professor of Economics, and Anastasia S. Zervou, Assistant Professor of Economics, test to what extent surprises in monetary policy affect stock price returns and analyze how this relationship has changed over time. Specifically, the authors track the response of stock price returns to unanticipated changes of monetary policy and explore the evolution effect of monetary policy surprise on bond returns. It is reasonable to hypothesize that since the conduct of monetary policy and operation of financial markets has changed over time, so has the relationship between the central bank and the stock market. For example, in recent decades, the Federal Reserve has gradually