Abstract
What is the impact of interest rate and monetary policy on the stock market? Some studies find a positive impact of expansive monetary policy on stock prices others prove the opposite. This paper examines the effects of monetary expansion and interest rate changes on investment behavior on the stock market by illustrating two behavioral experiments with students. In our experiments the increase of money supply and the decrease of interest rates had a direct positive impact on share prices. These findings support the hypothesis that extreme expansive monetary policy with low, zero or negative interest rates encourage financial bubbles on the stock market. To avoid a crash the exit from such a policy must be slow. As happened in 1929, crashes can damage the financial system and the real economy. Central banks must take this into account in their monetary policy.
Highlights
After the financial crisis and in the Covid-19 crisis many central banks turned to quantitative easing (QE) to support economic growth
Central banks have a strong responsibility for the stock market if they increase the money supply disproportionately to the real production
The sharp increase in interest rates and the stoppage of money supply increase led to a stock market crash due to quick portfolio adjustments
Summary
After the financial crisis and in the Covid-19 crisis many central banks turned to quantitative easing (QE) to support economic growth. Some central banks even pushed short-term interest rates slightly below zero to stimulate the economy. Especially in Europe, has raised questions about the benefits of QE bond purchases versus their detriments and whether their effectiveness has reached a limit. What is the impact of such an expansive monetary policy on the stock market? Some find a positive impact of expansive monetary policy on stock prices others prove the opposite. Against such a background this paper examines the effects of monetary expansion and interest rate changes on investment behavior on the stock market by illustrating two behavioral experiments with students. The results are presented (section 4) and the conclusions drawn (section 5)
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