Abstract
This section provides an aggregated overview of the results of the main hypotheses. Below is a brief overview. This is followed by a detailed discussion of the findings and an analysis of how these findings relate to other studies. Table 7.1 shows the empirical results of the hypotheses with respect to the main objectives of this contribution across the eight regions of the analysis.
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Notes
- 1.
For example, Bagliano and Morana (2009, p. 441) find strong evidence of international comovement among real stock returns. However, preliminary cointegration analysis between the included stock market indices and global forces did not suggest that a common trend exists, which drives stock markets across countries.
- 2.
To enhance readability of the table the coefficients to the parameters of the cointegration relations are left out. The idea here is to gain understanding of significant relationships between the variables. A more detailed view of the cointegration relations is presented in the respective country analyses.
- 3.
For a theoretical model that describes the persistence of stock market bubbles, see Abreu and Brunnermeier (2003, pp. 178–197).
- 4.
For example, Alan Greenspan’s warning of ‘irrational exuberance’ in 1996 came four years before the end of the dot-com bubble, with the Dow trading at 6.500 points and perhaps too early to be taken seriously by market participants (Ito 2003, p. 549).
- 5.
The main focus in this contribution is on the interplay between money and stock prices and the role of central banks. Therefore, behavioral aspects of stock markets are only tested in so far as their role is inherently assumed in the long-run persistence of stock markets.
- 6.
See, for example, Ratanapakorn and Sharma (2007), Kwon and Shin (1999) and Mukherjee and Naka (1995). However, since the cointegration space is not restricted in these analyses, their confirmation has to be interpreted with caution.
- 7.
One has to keep in mind, though, that the empirical findings herein are based on boom and non-boom conditions. The focus is on the total sample and the general relationship between money and stock prices instead of being restricted to boom and bust phases.
- 8.
South Korea is regarded as a developing country even though it is by now considered developed. However, since the analysis focuses on the last 25 years, it is fair to say that over that time period it was in transition from a developing to a developed country.
- 9.
Positive findings are stronger for analyses that exclusively focus on boom-bust episodes, such as Adalid and Detken (2007) and Bruggeman (2007). However, even in boom-bust analyses, it is difficult to prove the importance of real money developments for the stock market econometrically, see, for example, Pepper and Oliver (2006) and Congdon (2005).
- 10.
Since housing prices are not included in the analysis, this is not tested herein.
- 11.
Greiber and Setzer (2007, pp. 15–17) support this finding in their US analysis.
- 12.
This, again, is not tested herein since commodity price indices are not part of the system. For analyses, which identify the positive impact of global liquidity on global commodity prices, see, for example, Belke et al. (2009, pp. 21–23) and Browne and Cronin (2007, pp. 19–22, 30–31).
- 13.
Approximately 200 of the 500 companies listed in the All Ordinaries Share Price Index conduct business in commodity related areas (Standard & Poor’s 2009).
- 14.
In addition, a portion of the created liquidity has been invested abroad (carry trades).
- 15.
This was one reason not to focus on the traditional measure of capital flows, which is the current account of the BoP, but to determine, which parts of capital flows affect monetary aggregates (see Sect. 4.6.3). Unfortunately, this has not delivered much additional insight for the behavior of developed economies’ stock markets.
- 16.
This finding confirms previous analyses of the effectiveness of changes in the policy rate. For an overview of the policy rate and house prices, see Kohn (2008, p. 5) and the mentioned articles. One should note, though, that most articles focus on the fed funds rate and the US market. This contribution, however, confirms this result for other markets as well.
- 17.
In addition, since all variables are treated as endogenous from the outset, the analysis is not subject to an endogeneity bias (Ehrmann and Fratzscher 2004, p. 722). This is advantageous because interest rate changes are not considered purely exogenous.
- 18.
Confirmation of hypotheses in brackets, (yes), demonstrates that the effect is only significant in the short run.
- 19.
One explanation of the strong role of money in the US economy can be derived from the importance of the financial sector for US GDP. Up to the current financial crisis, abundant liquidity enabled banking sector revenues and profits to propel in comparison to other sectors.
- 20.
See also Reinhart and Rogoff (2009, pp. 4–10) and Helbling and Terrones (2003, pp. 69–70) for consequences of stock market and real estate busts for the real economy. See Mauro (2000, p. 3) for an overview of studies that document the positive relation between the stock market and economic activity.
- 21.
See article in the Wall Street Journal (WSJ) on Cleveland Fed Inflation Model that predicts low inflation rates 30 years into the future (WSJ 2009, p. 1). This is one example of anchoring inflation expectations without changing the policy rate.
- 22.
See also Blanchard and Riggi (2009, pp. 18–19) for an analysis on changes in the macroeconomic effects of oil prices. They find that the lower importance of oil prices for economic activity is mainly due to vanishing wage indexation and credible monetary policy.
- 23.
‘Leaning against the wind’ does not include direct targeting of asset prices but the central bank’s willingness to tighten monetary policy at the margin. The effect of this tightening should slow down asset price growth, which is regarded as excessive and, thereby, decrease the chances of future financial instability and depressed growth (Assenmacher-Wesche and Gerlach 2008, p. 1). See also ECB (2005a, pp. 56–59) for a discussion on the bandwidth of potential monetary policy responses to asset price bubbles.
- 24.
For extensive discussions on the question of whether or not central banks should pay attention to asset prices, the reader is referred to, for example, Cecchetti et al. (2000), Bernanke and Gertler (1999), Smets (1997) and Goodhart (1995), who share different views on this question. In addition, Detken and Smets (2004, pp. 23–30) present a very objective literature overview of theoretical aspects of the ideal policy response to asset price booms and busts.
- 25.
See also Bernanke (2002).
- 26.
As theoretically outlined in Sect. 3.2.3.2, market psychology and irrational as well as rational behavior on the part of investors can lead to non-fundamental movements of stock markets.
- 27.
Greenspan (2002, p. 3) points to two problems which make ‘pricking’ bubbles particularly difficult. First, one must distinguish between a bubble and a fundamentally justified increase in prices. Second is the bluntness of monetary policy instruments. He considers interest rates to be too inaccurate to conquer bubbles without endangering the economy. On the one hand, if the rise in rates is too small, monetary policy may have no effect, or contrary effects. For example, economic agents may think the central bank has full control and, thus, be encouraged in their investing behavior. On the other hand, if the increase is too large, the economy may not face a bubble, but may dive directly into a recession instead. Therefore, in his opinion, it is wiser to wait until bubbles burst and to fight the aftereffects with monetary easing. This attitude was also elucidated in his mid 1999 congressional testimony, in which he stated that the policymakers duty is “to mitigate the fallout when it occurs and, hopefully, ease the transition to the next expansion” (Greenspan 1999, p. 7).
- 28.
See Sect. 5.2.2 for theoretical reasons, which are confirmed by the findings from the empirical analysis.
- 29.
See, for example, Kohn (2008), Stark (2007), Knight (2006), Trichet (2005), Ferguson (2005) and Issing (2004). In addition, Mishkin (2009, p. 1) acknowledges in a recent Financial Times article that credit boom bubbles should be targeted by central banks. All other asset price bubbles, however, should not. His reasoning is based on the devastating consequences of a credit boom bust compared to the milder repercussions of asset boom busts.
- 30.
In addition, it is widely assumed that increases in the policy rate must be so high as to have a significant effect on asset prices that this might lead to unproportionally high costs for the real economy (ECB 2005a, p. 57; Issing 2004, p. 2).
- 31.
Issing (2004, p. 2) points out that most asset price booms have been accompanied “by strong money and/or credit growth”. In addition, Reinhart and Rogoff (2008, pp. 24–33) find that costly banking crises are usually preceded by large capital inflows, credit booms and asset price booms.
- 32.
In addition, high leverage levels can be associated with costlier boom-bust phases (Trichet 2005, p. 4). Consequently, lower leverage levels may help to lower the costs of a potential post-boom recession.
- 33.
Schwartz (2002, p. 11) presents flexible capital requirements as a policy alternative for the BoJ in the 1980s. In her opinion, capital requirements that change with the ratio of a loan category to total loan portfolio could have led to healthier bank balance sheets and a sounder financial system. If ratios rise too high, banks would have to liquidate assets to keep the ratio in line with the capital requirements. As a result, the portfolios of Japanese banks would not have been as biased and as vulnerable to the subsequent downturn.
- 34.
Other regulatory measures could be helpful to stabilize financial markets but are beyond the scope of this contribution. Münchau (2009, p. 1) suggests focusing on potential causes of bubbles, such as the size of the financial sector, the too-big-to-fail issue and bankers’ extreme tendency to load on risk.
- 35.
In addition, transparency also has the potential to reduce stock price volatility. This is based on the assumption that monetary policy is not predictable and transparent enough for investors to form consistent long-run expectations. Consequently, stock prices fluctuate more than necessary. Stock price volatility could be reduced if the central bank reduced uncertainty of subsequent policy rate changes because the ‘option value of waiting’ of portfolio and investment decisions would be reduced (Belke and Polleit 2006, p. 336).
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Wiedmann, M. (2011). Summary of Empirical Analysis and Policy Implications. In: Money, Stock Prices and Central Banks. Contributions to Economics. Physica, Heidelberg. https://doi.org/10.1007/978-3-7908-2647-0_7
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