Uncertainties under monetary tightening and easing shocks and different market states

Abstract

We examine the impact of monetary policy shocks on monetary policy and stock market uncertainties, testing for asymmetric responses to tightening/easing shocks, business cycle phases, and stock market volatility regimes. To identify monetary shocks, we use a theoretical vector autoregressive model of the US economy that accounts for the interconnectedness between monetary policy and the stock market, augmenting it to accommodate for unconventional monetary policy actions at the zero lower bound. Then, with local projections, we estimate the uncertainty responses of monetary policy and the stock market to such shocks. Our main findings suggest that monetary policy holds promising potential as an effective countercyclical tool to reduce uncertainties, through easing policies in recessions and tightening policies in expansions and/or tranquil stock market volatility regimes.