Impact of Monetary Policy on Financial Markets Efficiency under Speculative Bubbles: a Non-Normal and Non-Linear Entropy-based Approach

Abstract

This paper examines, through the concept of mutual information based on Shannon’s entropy, the impact of monetary policy on the loss of efficiency in the financial markets due to speculative bubbles. The proposed information measure is useful to quantify the efficiency with which stock markets respond to the implementation of monetary policy. The findings show that an increase in both money supply and credit growth, as well as declining interest rates, lead to strong market inefficiencies during the initial periods of formation of a bubble. Moreover, empirical evidence suggests that when a loose monetary policy (money supply is expanded and is accessible to agents to encourage economic growth) generates inefficiencies, its instruments are not effective to realign the performance of financial markets. JEL Classification: E5, G14, D84, C60.