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Stock Market Volatility and Monetary Policy: What the Historical Record Shows

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Stock Market Volatility and Monetary Policy: What the Historical Record Shows 108 Barry Eichengreen and Hui Tong Stock Market Volatility and Monetary Policy: What the Historical Record Shows Barry Eichengreen and Hui Tong1 1. Introduction This paper presents a fact – we are tempted to say a ‘new factʼ, since to our knowledge it has not been recognised before. The fact is that stock market volatility, when viewed from a long-term perspective, tends to display a u-shaped pattern.2 When we take data spanning the 20th century for todayʼs now-advanced economies – all of the economies for which such a long time series of fi nancial data are available – we generally see that volatility fi rst falls at the beginning of the period before stabilising and then rising in recent years.3 Any blanket generalisation about fi nancial market behaviour is problematic when one attempts to apply it to a signifi cant number of countries. There are exceptions to the rule, as noted below. But there is some evidence of the u-shaped pattern in a substantial majority of the countries we consider. Our interpretation of this pattern is as follows. The decline in volatility in the early, pre-World War I period refl ects ongoing improvements in the information and contracting environment, which fi nd refl ection in the improved operation of fi nancial markets. Indeed, there is a considerable literature on the growth and development of fi nancial markets in this period, although it has paid relatively little attention to stock markets, given their still limited role in resource allocation. Following 1. The authors are George C Pardee and Helen N Pardee Professor of Economics and Political Science and Graduate Student in Economics, both at the University of California, Berkeley. This paper was prepared for the Reserve Bank of Australiaʼs annual research conference on Asset Prices and Monetary Policy, Sydney, 18–19 August 2003. We are grateful to Andrew Rose, Michael Jansson, James P

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