The impact of monetary policy on stock market : an empirical evidence from the US and European equity markets

Abstract

This study empirically investigates the impact of monetary policy on stock market returns in the US and EU based on a sample of monthly data between 2000 and 2018. Monetary policy is proxied by the short-term sovereign bond yields, as well as by other key macroeconomic variables incorporating monetary policy decisions through several transmission channels. Multiple regression model was adopted to measure how the returns of broad market indices in both regions, namely the S&P 500 and STOXX 600, are affected by each explanatory variable. The structural models are further extended to discover whether the impact of monetary decisions on equity returns was different during the Global Financial Crisis and the European Debt Crisis. Both fundamental models are subsequently tested for the evidence of long-term interrelationship between the variables via the ARDL Bound Co-integration Test. The study showed mixed results for two regions, where the restrictive monetary policy in the EU leads to lower stock returns while pushing the US markets higher. As expected, higher long-term yield reduces the demand for equities due to the substitution effects and a higher discount rate. Contrary to monetarist theories, however, we found no significant link between liquidity injections and equity returns in the US and, in fact, a significant negative relationship in the case of the EU. The study also confirms the existence of a long-run relationship between all the variables, which tend to converge to their equilibrium values with time.