TAILIEUCHUNG - Why the Fed Should Ignore the Stock Market

The overwhelming expansion of the internet is today being accompanied with a large increase of financial activities and transactions that are conducted on- line. A few minutes navigation on the internet allows to realize the existence of electronic cash systems,payment protocols,auctions,lotteries,digital casinos and gambing systems. The sometimes crucial importance and often large inter- est around such transactions raises several concerns about the security and the privacy of the information that users and organizations are willing to use on a network | Why the Fed Should Ignore the Stock Market James B. Bullard and Eric Schaling INTRODUCTION Equity Prices and Monetary Policy Rules The dramatic movements in equity prices in the United States during the last decade or so have focused considerable attention on stock markets as a barometer of economic wellbeing. Separately there has been growing interest in the use of nominal interest rate feedback rules for the conduct of monetary policy since the publication of Tầylor 1993 .1 These two developments have led to a debate over whether equity prices possibly belong in a policy rule of the type that Taylor recommended. One way to pose this question is to ask Should monetary policymakers using Thylor-type rules include in the rule a reaction to movements in the level of equity prices 2 Another way to pose this question is to use the language that a variable included in a reaction function of the policy authority is a target variable. Then we can ask somewhat more provocatively Should monetary policymakers target the level of equity prices 3 As an empirical matter Rigobon and Sack 2001 report that the Federal Reserve does in fact react to changes in stock market valuations when adjusting its instrument the intended nominal federal funds rate. The main finding of Rigobon and Sack is that an increase of 5 percent in the value of the Standard Poor s 500 stock index raises the probability of a 25-basis-point increase in the intended federal funds rate by about one half. Their findings are symmetric with respect to a decrease in the level of equity prices. According to these results then if the probability of a decision to raise the intended federal funds rate by 25 basis points had been 20 percent and the S P 500 unexpectedly increased by 5 percent the probability of the decision to raise James B. Bullard is an assistant vice president and economist at the Federal Reserve Bank of St. Louis. Eric Schaling is a professor of economics at Rand Afrikaans University and thanks the

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