Did the Fed and ECB react asymmetrically with respect to asset market developments?

Abstract

This paper studies the monetary policy of the Federal Reserve (Fed) and the European Central Bank (ECB) with respect to stock or/and foreign exchange markets from 1979 to 2009. I find that during the Greenspan era stock markets played a role in US monetary policy. The Fed lowered interest rates when stock prices fell, but did not raise interest rates in response to rising stock prices. This asymmetry put a downward pressure on interest rates. For the ECB, the exchange rate to the dollar played a role in monetary policy decisions. While I do not find evidence of asymmetric monetary policy with respect to the stock market, the ECB may be argued to have indirectly followed the asymmetric US monetary policy via the exchange rate channel until 2006, the period until which the dollar depreciated heavily against the euro. With asset markets putting a downward pressure on interest rates, it is likely that the Fed and ECB contributed to recent boom-and-bust cycles by providing low-cost liquidity to flourishing markets. Relevance and implications of the findings are discussed.