Dynamic Linkages Between Monetary Policy And The Stock Market

Abstract

This paper examines the dynamic linkages between the federal funds rate and the S&P500 index for the 1970-2003 period, decade by decade, using cointegration and error-correction methodologies. The results indicate absence of cointegration during the 1970s and the 1980s but presence of a dynamic, short-run relationship between the two variables only in the 1970s. Specifically for the 1990s, there seems to have been a disconnection between actions taken by the Fed and responses by the stock market or vice versa. Overall, the results seem to suggest that there was no concrete and consistent dynamic relationship between monetary policy and the stock market and that the nature of such dynamics was different in each of the three decades, which coincided with three different Fed operating regimes.