Monetary Policy and its Effects on Stock Markets Essay

Monetary Policy and its Effects on Stock Markets - Essay Example Despite claims that monetary policy should not affect stocks, there is evidence that the policy can affect real stock prices in the short run (Bernanke & Kuttner 2005) and also an opinion that the nature of the monetary policy regime can affect the performance of asset markets over longer horizons. It has also been observed that by altering the path of expected dividends, the discount rate or the equity premium is one of the effects of the monetary policy on stocks1 Observers of Financial Markets have noted that an unexpected decrease in the federal funds rate target leads to a rapid and positive reaction in stock prices thus implying the effect of the Monetary Policy on Stock Markets. Research Methodology - Our research methodology includes secondary data indicating the effect of policies on stock markets. We shall also examine the behaviour of important macroeconomic and monetary policy variables during stock market booms which will lead us to understanding the effect of macroeconmic policies like the Monetary Policy on Stock markets. The effects of Monetary Policy on Stock Markets. Monetary Policy Tools that affect stock prices Discount Window Lendings - The Monetary Authority can directly change the size of money supply by using the Discount Window tool. By calling in existing loans or extending new loans, the money supply in the country is regulated. When the money supply is ample, investors look to investments and when money supply is low, invetments are diluted to increase liquidity. Thus Discount Window Lendings influences stock prices. Reserve Requirement - A certain reserve of their assets is meant to be held by the Central Banks which is for withdrawals and the remainder is normally invested in mortgages and loans. A change in the reserve... In this essay, the researcher aims tol ascertain the importance of the Monetary Policy and its effect on the stock markets. Despite claims that monetary policy should not affect stocks, there is evidence that the policy can affect real stock prices in the short run and also an opinion that the nature of the monetary policy regime can affect the performance of asset markets over longer horizons. The research methodology includes secondary data indicating the effect of policies on stock markets. The researcher also examines the behaviour of important macroeconomic and monetary policy variables during stock market booms, which lead to understanding the effect of macroeconmic policies like the Monetary Policy on Stock markets. The researcher then concluds that early effects of the monetary policy can be observed when asset prices tend to focus on the impact of changes in liquidity on the demand for various assets that compromise the portfolio of the Private Sector. Extended periods of ra pidly appreciating equity housing and other asset prices in the United States and elsewhere since the mid 1990s have increased attention towards the effects of monetary policy on asset markets. The researcher also can conclude, that 20th century stock market booms typically were associated with the business cycle arising, when output growth was above average and ended as output growth slowed showing the effect of economic policies which affect stock markets and the stock markets globally are affected by Monetary Policy.