The transmission effects of monetary policy on the equity market

Abstract

We do not know for certain the exact transmission effect monetary policy has, or how significant this transmission effect on key economic variables may have on the equity market. There have been many school of thoughts along with different opinions. In fact several commentators believe that accommodative monetary policy i.e. low interest rates will result in the equity market to boom. However, in reality it may not always be the case, as a rise in interest rates contributed higher equity returns. This research attempted to analyse the effects of the transmission of monetary policy on the equity market, through interest rates and other economic indicators, across Europe, the United States and United Kingdom. This was examined by use of a multiple regression model and VAR model via a Granger Causality Test and Impulse Response Function. For the first part of the model, via the regression model, the research results confirm what certain financial institutions have discussed- that it is generally a rise in interest rates that would make the equity market to increase. However, when adopting a VAR approach, the results retrieved via an Impulse Response Function were not as bold and clear as that found from the regression model.