Has the Fed Reacted Asymmetrically to Stock Prices?

Yes. To the extent that monetary policy is assumed to react to asset prices, this reaction is usually assumed to be linear. This paper o¤ers a new perspective. I augment the model of Rigobon and Sack (2003) to allow for asymmetric reactions to stock price changes. I then demonstrate that the Federal Reserve has been following an asymmetric monetary policy rule over the period 19982008. While a 5% drop in the S&P 500 index is shown to increase the probability of a 25 basis point interest rate cut by 1/3, no signi…cant reaction to stock price increases can be identi…ed. Keywords: Monetary policy, asset prices, interest rate rules. JEL classi…cation: E44, E52, E58 1E-mail: [email protected]. I would like to thank Henrik Jensen for competent and inspiring supervision, and Emiliano Santoro for many useful comments. Moreover, thanks to Niels Blomquist, Anders Borup Christensen, Hans Christian Kongsted, György Molnar, Virginia Queijo von Heideken, and seminar participants at Danmarks Nationalbank and the University of Copenhagen for relevant comments and suggestions. Finally, thanks to Lars Jul Overby for his help in obtaining the data. The views expressed in the paper are my own, and do not necessarily correspond with those of Danmarks Nationalbank. Any errors or shortcomings are of course my own.