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Name and Surname : Kalpesh Kishor Pindoria
MSc Programme : MSc Investments and Finance
Title : Monetary policy and Stock Market
Name of Supervisor : Stefan van Dellen.
Word count : 7300

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TABLE OF CONTENTS
TABLE OF CONTENTS .............................................................................................................................. 2
ABSTRACT ............................................................................................................................................... 3
INTRODUCTION ...................................................................................................................................... 4
Link between stock prices and the Economy .................................................................................... 4
Effects of monetary policy on stock market performance ............................................................... 6
LITERATURE REVIEW .............................................................................................................................. 7
TAYLOR RULE EXTENSION WITH ASSET PRICES ................................................................................. 9
ASSET PRICE VOLATILITY .................................................................................................................. 11
EMPIRICAL STUDY ................................................................................................................................ 13
DATA ................................................................................................................................................. 13
DATA SETS USED IN MODELS ....................................................................................................... 13
Methodology ........................................................................................................................................ 13
TAYLOR RULE .................................................................................................................................... 13
AUGMENTED TAYLOR RULE ............................................................................................................. 15
COMMENTS ON RESULTS ..................................................................................................................... 20
CONCLUSION ........................................................................................................................................ 21
REFRENCES............................................................................................................................................ 23
APPENDIX ............................................................................................................................................. 27

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 MONETARY POLICY AND STOCK MARKET

ABSTRACT
This paper investigates about the effects of monetary policy on stock market considering four varia-
bles (Stock market Indices, GDP, Base Interest rate and CPI) driving the stock market returns in group
of 7 countries (G7) period of over 1999-2017. G7 countries are developed countries and therefore
are stable markets if some adjustments happen have impact on either developing or emerging mar-
kets latter. With globalization all markets are interlinked and impact of one market have some con-
sequences on other. This study has been carried out with Linear and non-linear Taylor rule (Aug-
mented Taylor rule). We check whether there exists any relationship between monetary policy and
stock market or they perform independently and whether there have been any changes since so far
in forming monetary policy or is it same as used to be before. We take into consideration of rising
uncertainties in market with increasing globalization.
Appreciating liberalization in foreign cash inflows, there is a direct impact on exchange rates which
fluctuates asset prices. In past two decades, there has been several economic downturns (financial
crisis or shocks). This shock points out to improper regulation in market and increasing instability in
the market. With this, a question arises if central banks are liable for maintaining stability in the fi-
nancial market? With the interest rate implementation, it does not say whether how and which vari-
ables should be used to augment Taylor rule, so in our model to avoid this confusion we consider
target interest rate as zero (0) to which it does not have any impact and interest rate depends on ac-
tual inflation and output. This study augments Taylor rule with asset price volatility which is consid-
ered as an indicator of financial instability in the market. As linear Taylor takes Inflation and output
gap into consideration which is a general rule. Augmenting Taylor rule helps us getting a better con-
clusion. Our results point out there exists a direct and indirect relationship between stock market
and inflation and output. Which means with high interest rate stock markets tends to go up and vice
versa. So, get some more information out of our model re-estimating model it adds some variability
to our model which helps in getting a better idea as our data is auto-correlated. Re-estimating model
helps in determining existing relationship between our variables.

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INTRODUCTION
There has been much advance in international financial integration intending in the years earlier
than Lehman Brothers (2008) and Dotcom Bubble (2000), both in goods and financial markets. “Em-
pirical realizations of macroeconomic factors in one financial system represents an expansion of an
statistical patterns in rest of the world”.
Concerns with respect to volatility have picked up significance from beginning of the worldwide fi-
nancial crisis in 2008. Considering the role of monetary policy, it is not very sure whether central
banks should be liable for financial stability with performing their common role. This regulating de-
bate has been carried out with planning, but to date without any agreement. Defenders contend
that financial stability will bring enhancement to an adaptable inflation focusing on system. In spe-
cific, it has been mentioned that central banks ought to be effectively utilizing the interest rate to
incline against the wind of monetary imbalance (Woodford 2012). “At the same time, while other
experts are being more skeptical and feature the conservation focusing on financial stability to ad-
ministrate instruments rather than interest rate (e.g. Svensson, 2012)”. Despite the main part of cen-
tral bank is in protecting financial stability for number of reasons (Shinais, 2003), this scheme gets
complex by the truth that financial stability is considered as an open good whose research might
produce a trade-off with achievement of policy objectives (Allen and Wood 2006). As a result, the
lawful premise for advancing budgetary stability should be clear as conceivable to characterize the
duty and to assess the execution of the central bank. In practice, indeed although there are few an-
gles that can be credited to financial stability investigations, those linkage are or maybe unclear for
most central banks and are moreover heterogeneous among them. Compared to big coincided goals
of price and output stability, financial stability is not often counted as an obvious policy variable
within the framing of policy (Oosterloo and de Haan, 2004). However, this subject has recently
picked up importance within the argument on whether central banks should still perform under their
choice of. It is some of the time resisted that in case of “financial stability serves as a precondition
for financial and macroeconomic stability, at that point no explicit detailing of such an objective
would be required at all to act with statutory boundaries (Baxter, 2013)”.

Link between stock prices and the Economy

According to some economic theory, it proposes that there ought to be some strong connection be-
tween financial movements and security costs, given that stock price is the reduced esteem of firm’s
payout. If that’s a genuine action such relationship should be present. The standard discounted cash
flow model suggests that if stock prices lead to honest financial movement in case of investors spec-
ulations about firms’ future payout tend to be correct on average. There is one imaginary argument
that shows the relation between stocks and financial yield. There is some assumption as how stock

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prices can have a coordinate influence on financial yield, encourage fortifying the interface within
relationship between these variables.
To begin with, Tobin (1969) proposed midpoint of effect that stock prices have on the cost of capital
and which can be known by a coefficient called Tobin’s Q, is the amount of market value of current
capital to cost of substitution capital. So, this means with high stock prices, the value of firm relative
to substitution of its pile of capital is also high. Thus, leading to increase in speculative consumption
and higher sum of financial yields as it becomes for firms to back their venture expenditures. This
happens since investments would be simpler because now as they require less share offerings in an
event of high prices.
The moment channel by which stock market execution may have influenced GDP was proposed by
Modigliani (1971). His recommendations work through impression that wealth variables has on utili-
zation. A persistent increment in security cost comes about in an increment within the individual’s
riches possessions and thus higher unchanged salary. Through the unchanged lasting salary specula-
tion, Modigliani hypothesized that temporarily, customers maintain utilization in order to arrange
maximum utility. An increment in lasting pay will hence influence buyers to shift upwards their utili-
zation levels in each period.
“Third suggestion of through which suggest that stock prices affect yield is being indicated to as
monetary speeding up variable (Bernanke and Gertler, 1989; Kiyotaki and Moore, 1997)”. This chan-
nel centers on changes in Balance sheet of a firm because of stock prices. With presence of unbal-
anced data in credit markets, the creditworthiness then depends on how much collateral a firm can
promise for the borrowings. Schwert (1989) endeavored to think about relationship between finan-
cial action and stock returns by analyzing the relationship between instability in financial action and
instability in stock prices. Schwert somehow finds proof that stock market instability depends on
wellbeing of economy.
Thus, this uncertain standardizing discourse at that point expands to the level of arrangement imple-
mentation. For last twenty years, interest rate is outlined with the rules of arrangement based on
the well-known work of Taylor (1993). Taylor rules targets the price and output stability which are
now widely known. However, within the light of recently growing anxieties for financial stability the
query comes up if, and if yes, how central banks would hunt for such objective. As a part of central
banks activities, a huge body of writing has aimed the incorporation of different kinds of stability
measures within the Taylor rule. Taylor rule has been augmented with exchange rate, credit/lever-
age, and asset prices. We mainly focus on asset price volatility in our model.

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 Effects of monetary policy on stock market performance
Monetary policy is utilized by central banks or government as a mean of regulating interest rates to
maintain money supply in economy. Central Banks of every nation play a vital role in defining and
implementing for government to attain some objectives considered as macroeconomic variables
such as attainment of certain level or desired level of development in prevailing activities,,
the trade rate, the cost level or inflation, the adjustment of payments, real output and employability.
Monetary policy can be out into action with the impacts of cost and accessibility to credit borrowing
and through this on inflation, and universal capital developments and thus on rate of exchange. “Ac-
tions such as changes in Central Banks discount rates have a backhanded impact on macroeconomic
variables and considerable lags are included within the arrangement of transmission mechanism”
(Christos Ioannidis and Alexandros Kontonikas, 2006). Agreeing to Bernanke (2004), the Federal Re-
serve Bank (central bank of USA), as frequently addressed as Federal Reserve Bank (Fed), objectives
are “Price stability” and “sustainable economic growth”. In recent times, Federal Reserve Bank au-
thorities and academic scholars addressed whether, should central banks consider asset prices sta-
bility with price level stability. Monetary policy utilizes various variables which incorporate intrigued
rate, reserve requirements, specific credit controls, rediscount rate, Treasury bill rate amongst oth-
ers.
Monetary policy always alluded to development approach, or tightening policy. Expansionary ap-
proach aims to increase supply of cash in economy quickly or diminishes interest rate. Whenever
government wants to follow this approach, it will buy government bonds from stock market with
money to infuse circulation of cash in the market/economy. Expansionary approach is conventionally
used to reduce unemployment in times of depression. Contractionary approach is opposite of ex-
pansionary approach as it lowers down total money supply or allows it to increase slowly or will raise
interest rates. When implemented by central bank it sells government bonds in return for money
and reduce money circulation in economy.
Stock market is a capital market institution and considered to be a secondary market in which pre-
vailing securities are traded, as restricting the initial issues, can be traded on. Stock market is influ-
enced through two channels. The first, proposed by Greenspan (1996) is that ups and downs in secu-
rity prices are due to total consumption through wealth channel. Second, movements in stock prices
also impacts financing a business.
Many macroeconomic and financial factors that impact stock market somehow have been recorded
in some literature research without an agreement of their fittings to as regressions. Regularly cited
macroeconomic factors as GDP, Price level, Industrial production rate, Interest rate, rate of ex-
change, Current account adjustments, unemployment rate, fiscal balance, etc.

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LITERATURE REVIEW
“Monetary policy aims to gain set of goals expressed in macroeconomics variable such as inflation
and real output”. However, modifications to policy can change variables and affects implementation
of policies by central financial institutions. While financial markets are very sensitive to new infor-
mation coming up in the markets and have high impact on monetary policy which can be known by
statistical data. With having Knowledge of relationship between stock returns and monetary policy is
more important to get better idea about implementation of monetary policy as stock prices are vital
and sensitive to new information.
In this paper, through empirical evidence we identify main factors driving stock prices. Stock prices
are considered important factor in determining value of company and as most sensitive to infor-
mation that comes in market. This are more closely examined by experts. About transference from
stock market, monetary policy has its influence on stock prices, which are connected to real econ-
omy through various factor.
As Discounted cash flow model says stock prices are present value of expected future cash flow.
“Monetary policy then plays a vital role in determining equity returns if discount rates are manipu-
lated used by market participants for future activity”. Since they are both internally connected. With
more intense monetary policy leads to high discount rates and low future cash flows resulting in
lower stock prices. Broader monetary seems to be beneficial for all as it is related with low interest
rates, more economic activities and more earnings. Market participants are more likely concerned
about policies implemented as it says a lot about the future activities of monetary authority and is
indicator of central bank policy. Movement in stock prices are often regarded as reaction to financial
arrangements, ascribing for occasional increments in stock markets to lower interest rates.

TRADITIONAL TAYLOR RULE

Since the foundation, by Taylor (1993), of the direct logarithmic interest rule that indicates how
the United States (US) Federal Reserve (Fed) amends Federal Funds rate of Inflation and output
gap, as few papers suggests method to check the validity of the rule for other nations and time inter-
vals.
Sometime before few studies pointed out that Taylor rule has considered the impact of other fac-
tors within the behavior of monetary policy. One critical expansion is related to the incorpora-
tion of resource prices and monetary factors within the rule. This conflict have given birth to
huge talk within the writing: whereas few creators consider it vital that central banks intend to tar-
get asset costs, others oppose this idea. To add more to this debate, we ask whether the conven-

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tional Taylor rule take a further step and expand this search with an elective variable that has and in-
tegrates the relevant market information from the monetary markets, i.e. whether central banks fo-
cus on other relevant economic information from a group of monetary factors and not just focusing
on each budgetary variable. Thus, this initially aims to a simple Taylor rule considered by the Euro-
zone, US and Joined together Kingdom (UK) with increased use of financial conditions index that
consists of data of few financial variables.
The traditional Taylor rule is an ideal rule which is determined from the minimization of a symmetric
quadratic loosing function of central bank’s believing that the aggregate supply is direct. Therefore it
might not happen, and the central bank can have uneven inclinations – i.e. it might consider the dif-
ference weights ranging from negative to positive of inflation and output gaps in loss func-
tion – later, not the nonlinear Taylor rule. Before some time, studies begun to consider the asymme-
tries or nonlinearities (issues related to stability of market) while inspecting monetary policy func-
tions.

To begin with, monetary policy and financial soundness can very well be known by the help of Tay-
lor rule (1993). As per rule, central banks set interest rate depending on harmony of base interest
rate and inflation rate. To add more, banks takes gap between actual inflation rate and potential in-
flation and actual output and potential output. This can be put into equation as follows:
𝒚𝒕 = 𝜶 + 𝜷(𝝅𝒕 − 𝝅𝒕 ∗) + 𝜸(𝒚𝒕 − 𝒚𝒕 ∗) + 𝝐𝒕
As per Taylor Rule (1993) assigning different weight (0.5) to the inflation and output gap and keeping
inflation target of 2 %, Taylor rule seem to fit the behavior of the Federal Reserve (USA) from 1987
to 1992 reasonably well. “However, as Clarida et al. (1998), among others, point out, it is the base in-
terest rate that is considered in economic decisions, and the central bank can alter this rate in
the presence of base wage and/or cost rigidities”. The base interest rate can be achieved by:

“As Taylor notes, the policy implications are as follows: if (or both), then
”. Considering this, central bank will intend to push base interest rate to get hold on the econ-
omy and works the way around. However, Taylor mentions that this rule might not be required to be
taken after mechanically in practice.
This rule has been in limelight for over two decades but is impossible to mention all the possibilities
of thoughts. Considering this, there is one doubt whether there is any meaning of doing this as Tay-
lor rule as initial weights were chosen subjectively by Taylor (1993). However, Rotenberg and Wood-
ford (1997) says that central banks loss function can be used on micro level to determine response

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of variables towards monetary policy. In this way, weights are now not chosen self-assertively but
depend on house-holds’ choice, the manufacturing innovation and the degree if price rigidity to ex-
pand well-being. Thus, although economic stability is not a concern at the micro level foundation,
the Taylor rule most of the time used commonly within discussions if central banks should pay atten-
tion to financial instability or not which is a growing concern worldwide.
Nevertheless, considering number of papers concerned with stability issues (see, e.g., Clari-da et al.
2000). 1st issue (not associated to stability) concerns to be linked with reaction to inflation. To keep
economy stable, the base interest rate should be increased a bit more than that of inflation rate, in-
ferring. Typically known as “Taylor principle”. The other issue is almost near to financial stability con-
siderations. This is for soothing interest rates meaning central banks are concerned about the pace
of interest rate adjustments. Policymakers know the reality of market with sudden change in interest
rate might put stability of market at chance, and afterward rate set as weighted as of simpleTaylor
rule and lagged interest rate.
However, these contemplations are not an issue here. The main challenge here is to express finan-
cial stability variable within Taylor rule. In general, one can easily augment this rule by inserting an
additional measure related to the financial stability to the equation (1). Where x is an additional
measure added to linear Taylor rule.

However, this is an unsolved mystery how should an extension of this rule should look like? Hence,
although number of papers are available representing augmented Taylor rule, it is still not been con-
firmed which parameters should be used in favor of financial stability. “As a result, some recent pa-
pers have considered indices that considers broad range of indicators (see, e.g., Albulescu et al.
2013, Baxa et al. 2013 or Castro 2011)”. On the other side, some papers are engaged as they permit
responses to wide range of financial fluctuations and are more reliable than others. Apart from this
they incredibly mix up policy communications and expectation. With respect to this paper, they too
come with some drawback of mixing up characteristics. Besides, it is not that unimportant to charac-
terize a target or balance measure for decided markers. There remain some questions as what will
be the value for the additional measure? If the problems can be solved, what should be the weight
of additional variable in forming monetary policy?

TAYLOR RULE EXTENSION WITH ASSET PRICES

The most highlighted part of the non-linear Taylor rule that relays to asset prices (combination of
house and stock prices). Most of the debates are in search and eager to know whether central

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banks should be liable for financial peace or to put on the same level as the question to consider as-
set prices as an additional variable to Taylor rule. In any case we did not intend to propose to assess
whether this rearrangement is right. Before going through some additional theoretical and empirical
papers related to monetary policy and asset prices, it seems easier to define for the previous. To
begin with, asset prices might have impact on inflation and output. This relation has been briefly ex-
plained by Gilchrist and Leahy (2002). To sum up, with rise in asset prices raises household’s wealth
and leading to increased consumption. On the firm side and the Tobin’s Q ratio, higher the stock
price tends to show higher profit margin. To add, with the increased securities value allows firm to
pledge as collateral for credit borrowings, in line with financial accelerator (Bernanke et al. 1999).
Thus, raising possibilities of getting more finance from external sources, which improves investment
and expenditure opportunities. As a result, increase in stock prices can be a hint to future possibili-
ties of inflationary pressures, indeed in case asset price are not considered to be a portion of infla-
tion measure. To add to those thoughts, Caruana (2005) focuses on the insistently rising asset prices
that can expose financial stability, indeed without deflation of price or output stability in the initial
occasion, they are likely to make insignificant bubbles that can crash and advance down the street.
This may in turn result in a genuine economic downshift. And if these resource climbs are financed
by intemperate credit development, they are indeed more unsafe.
The standardizing debate about asset prices, monetary policy and economic stability seems excep-
tionally much like a fight over two circles between Bernanke and Gertler (1999, 2001) and Cecchetti
et al. (2000, 2002). “The well-known work of Bernanke and Gertler (1999) begins to wrangle about.
Based on the monetary quickening agent approach of Bernanke et al. (1999), they take asset price as
financial contact”. “Bernanke and Gertler (1999) test execution of distinctive approach in this set-
ting. More concretely, they compare immaculate inflation focusing on policy rules (i.e. central bank
does not respond to output with inflation) with various forms also considering asset prices”. “Taking
the recreation of few surprises to this situation, they discover that an aggressive pure inflation focus-
ing on procedure with no response to asset prices performance measured by the impact on the vari-
ances in inflation and output gap”. Subsequently, there cannot be noticed any other response to as-
set prices than as of now included with inflation measure. Though, in short time they replied by simi-
lar imperative work of Cecchetti et al. (2000). They claim, it is insistently sensible for central banks to
respond to asset prices with inflation and output, whilst they highlight that central banks might not
predict them. To attain some conclusion, they expand their work of Bernanke and Gertler (1999)
along few measures. “Most imperative are the incorporation of an output gap measure within the
approach rule, an express inflation/output objective work for the central bank that can be reduced

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to assess ideal response coefficients, and some degree of interest rate smoothing”. With those ad-
justed considerations, the outcomes of “Cecchetti et al. (2000) challenge those of Bernanke and Ger-
tler (1999)” as they appear noteworthy points of interest from responding to stock prices in addition
to output and inflation. “As said, this is not the end. Bernanke and Gertler (2001) respond to work of
Cecchetti et al. (2000) and point out it solely relies on one special shock scenario which is equivalent
to five-period bubble and neglect other possible shock properties”. So, Bernanke and Gertler (2001)
now considers random selection of shocks and respond to output gap. They credit this result to a
transitionary adjustment of base interest rate to which monetary policy always reacts, not only as it
was in the stock market volatility. At last, Cecchetti et al. (2002) reviewed the debate and empha-
sized on that they never thought to target asset prices rather acknowledged that outcomes are
based on assumptions concerning fundamental stuns. But still some researchers believe that re-
sponding to asset prices may be helpful but should not be unimaginative. As both views recommend
including asset price data in several ways, the problem of how much reliable the data is and the
amount of that is involved in the inflation and output remains unanswered.
In a nutshell, widely accepted point within the literature is that the asset prices might not to be tar-
get for monetary policy but would like to respond, this appears to be unsuitable. Apart from this the-
oretical finding cannot agree on what should be the meaning of asset price in the terms of monetary
policy. Regardless this issue, the larger part of empirical studies shows few responses that interest
rate to asset price although there are few talk about on whether this are really to the addition to in-
flation and output contemplation.

ASSET PRICE VOLATILITY

Asset prices adding with equity price and real estate, are important variable. Despite knowing the
fact the asset prices are endogenous variable we cannot neglect the variable, there are sometimes
when asset prices are not related to the prevailing state of the economy is.” Amid the past two dec-
ades, economies around the globe has experienced inflation-recession cycles within the prices of dif-
ferent assets, including equities, residential housing and many others”. Considering this should
change in asset prices be the concern to monetary policy authorities? “In economist’s benchmark
case, world’s productive capital markets without administrative mutilations considering change in
asset prices often said to be change in original economic fundamentals”. Beneath these circum-
stances, central bankers would have no reason to concern them about asset price volatility. Asset
prices would then only be in the interest up till it provides with some glance about condition of the
economy.

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Things will change if, however, two conditions are fulfilled. The first condition is, non-fundamental
factors occasionally be the basis for asset market volatility. The second is the change with adjust-
ments in asset prices irrelevant to fundamental variables which has some possibly relevant impacts
on remaining economy. If these conditions are fulfilled, then asset price volatility becomes as an in-
dependent cause of economic instability, which must be taken care by policy makers while framing
monetary policy.
“Considering possible sources, “non-fundamental” oscillations in asset prices, two likelihood have
been proposing: poor controlling practices and defective level headedness from part of investors
(market psychology) “(Monetary policy and Asset price volatility, Ben Bernanke and Mark Gertler)””.
Borio and others presents a proof that economic reforms which rapidly raised access to credit to the
firms and households played a role in asset price booms during 1980s in Scandinavia, Japan, the
Netherlands and the United Kingdom. Money related easing in developing countries have open
gates for capital inflows from overseas have also played a role in sharply rising asset prices, with the
increased utilization and lending. “If liberalizing gives some extra power to private lenders and bor-
rowers, whereas government retains the guarantees of liabilities, excessive risk-taking following with
speculation and in many cases incrementing asset prices”. Ultimately, however fallacious money re-
lated conditions are visible to advancing and making asset prices to shrink rapidly. This situation
seems to illustrate practically well managing a banking crisis as lately experienced in some nations,
counting in United States and Japan, as well as East Asia and Latin America

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EMPIRICAL STUDY
DATA
Here to get some empirical evidence four variables have been considered upon which conclusion will
be drawn. Four variables are CPI (consumer price index), stock market Indices, Base interest rates
and Real GDP for group of 7 countries considered as developed economies in the world i.e. Canada,
France, Germany, Italy, Japan, UK, and USA. Main reason for considering these countries are devel-
oped countries and will have stable economies as compared to developed countries having more
ups and downs.

DATA SETS USED IN MODELS

CPI, Base Interest rate (set by central banks) and Real GDP Data was obtained from OECD Historical
data from (available at: https://data.oecd.org/interest/long-term-interest-rates.htm,
https://data.oecd.org/price/inflation-cpi.htm, https://data.oecd.org/gdp/quarterly-gdp.htm ) whilst
stock market indices from Bloomberg terminal. All data of variable are quarterly ranging from 1999:
Q1 to 2017: Q4. CPI (inflation) data has been collected from which CPI index has been generated and
as we don’t want inflation to have impact on our model we set(𝜋𝑡 ∗= 0). Thus, interest rate only
depends on actual inflation and output gap only.

Methodology
TAYLOR RULE
All variable data has been calculated, arranged and included in datasets as all tests are run in E-
Views to get statistical calculations. As we want to get an idea if there exists any relationship be-
tween stock market and monetary policy. We are using Taylor rule to determine our estimation. In
our case the regression equation will be as follows replicating the Taylor rule’s equation:
𝒚𝒕 = 𝜶 + 𝜷(𝝅𝒕 − 𝝅𝒕 ∗) + 𝜸(𝒚𝒕 − 𝒚𝒕 ∗) + 𝝐𝒕 (1)
So here (Y*) is potential output and GDP (actual GDP=Y), (𝜋𝑡) is the base interest rate and (𝜋𝑡 *) is
the potential interest rate and (𝜖𝑡) is the error term. So, after interpreting the equation it looks
somewhat like as follows:
GDP = (inflation gap) + output gap + 𝝐𝒕
In above equation inflation gap = Actual inflation - potential inflation, output gap= actual GDP – po-
tential GDP

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We have actual GDP data in our dataset we also need potential GDP to estimate our model. As our
model’s data set has historical data we need to get potential GDP to get output GDP, so we run Ho-
drick Prescott Fitler test (Hodrick and Prescott, 1997) with (lambda=100) and get potential GDP and
output gap as result which can be used further in our model. Whilst, considering inflation we as-
sume that inflation doesn’t affect our model for Inflation (IT). So consider value of potential infla-
tion as zero (IT*=0) therefore interest rates depend on output gap and actual inflation. We have all
the data to run test, so we start by estimating our regression by setting (significance level of 5%).
H0: Stock prices are affected by inflation.

Coefficient Std. Error t-Statistic Prob.

CANADA 1.672843 1.673254 0.999754 0.3207
FRANCE -1.33717 1.306429 -1.023533 0.3094
GERMANY -3.78301 1.570613 -2.408618 0.0185
ITALY -2.3327 1.508608 -1.546262 0.1264
JAPAN -1.59086 1.022501 -1.555856 0.1241
UK -7.38553 1.241982 -5.946565 0

` USA 0.034737 1.061212 0.032733 0.974

Table 1(values for CPI)

Estimating model by using equation (1) with OLS estimator we get results as above Table 1 looking at
p-value we reject the null for UK and Germany as (p-value <0.05) stock prices are not affected by in-
flation for this country. But for other countries stock prices are affected by the inflation as we fail to
reject null (p-value >0.05). This means in some way CPI is influencing stock prices and ups and downs
in inflation can change stock prices. So, this seems to be when there is recession the stock prices will
tend to be low.
Taylor (1993) suggests monetary policy should set β=ϒ=0.5. This says output gap and inflation has
equal importance in framing monetary policy. To check if output gap and inflation plays equal role in
our model, we test that with Wald Test by implying co-efficient restrictions as null:

Wald Test (H0: β = 0.5, γ = 0.5)

CANADA FRANCE GERMANY ITALY JAPAN UK USA
F-STAT 26.4155 31.69217 76.70719 57.32948 155.1008 41.627 25.23272
CHI SQUARE 79.2465 95.07652 230.1216 171.9884 465.3024 124.881 75.69815
P-VALUE 0.00000 0.00000 0.00000 0.00000 0.00000 0.00000 0.00000

Table 2
From above (Table 2), results are highly supportive with F-stat and Chi-square to reject our null as p-
values (<0.05). This indicates both inflation and output gap don’t have equal weight in forming mon-
etary policy.

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We came to know as inflation and output gap plays significantly different role in making monetary
policy, it might be possible that our model might have some shock effects as our data is from 1999:
Q1-2017: Q4 it might have some effect of Dotcom bubble (2001) or financial crisis (2008). Before
coming over to some conflicts in our model we might check for stability of our model specifically
shock effects. Our data range is of almost 2 decades we don’t have any knowledge about our time
series data it might have multiple shocks. To check that we check by multiple breakpoint test with
15% trimming, with maximum 5 breaks and significance level of 5%:
Considering multiple break points we use standard multiple linear model with T periods and m po-
tential breaks:
𝒀𝒕 = 𝑿′ 𝒕𝜷 + 𝒁′ 𝒕𝜹𝒋 + 𝝐𝒕
With the specific breakpoints m,{𝑻}𝒎 = (𝑻1 , … … . . , 𝑻𝒎 ). J = 0………, m

Multiple Break Point Test Result (F-STAT)

BREAKS CANADA FRANCE GERMANY ITALY JAPAN UK USA
0 vs. 1 31.0401 37.5975 67.49881 67.49881 15.72972 20.29724 14.48172
1 vs. 2 5.632835 16.28832 11.89336 11.89336 13.34571 10.85825 34.48018
2 vs. 3 46.5918 9.172984 18.7446 18.7446 8.76507 20.15643 8.309325
3 vs. 4 2.458694 6.478214 2.575623 2.575623 4.832915 3.377797 1.655953
4 vs. 5 - 0 - - - - -

Table 3
Results above (Table 3) indicates up to 3 breaks in our model. As we have small sample we cannot
add dummy variables to fix breakpoints as it might lead to misleading conclusion. Anyhow this con-
cludes that we have breaks in our model representing some shock effects or omitted values.

AUGMENTED TAYLOR RULE

Research indicates European and England central banks tends to use nonlinear Taylor rule but not
the Federal Reserve Bank. Which extend this research a bit forward by using augmented Taylor rule
approach as G7 countries (3 European countries out of 7). This might help adding some juice to my
research.
While estimating OLS in Taylor rule we used equation (1), but now augmented Taylor rule we add a
new variable called asset volatility which can bring more information to our model
Asset price volatility was generated by taking log of GDP and then by using {s=100*(asset-asset (-
4))}. This can be said as extended version of Taylor rule.
𝒚𝒕 = 𝜶 + 𝜷(𝝅𝒕 − 𝝅𝒕 ∗) + 𝜸(𝒚𝒕 − 𝒚𝒕 ∗) + ∑𝒏𝒌=1 𝞭𝒌 𝑺𝒕−𝒌 + 𝝐𝒕 …. (2)
Where, ∑𝑛𝑘=1 𝑆𝑡−𝑘 = asset price volatility

15 | P a g e
 k = no of lag for s
CPI OUTPUTGAP ASSET VOLATILITY G7
T-Stat P-value T-Stat P-value T-Stat P-value R-sqd. Adj. R-sqd.
CANADA 3.486011 0.001600 5.654564 0.000000 -0.521753 0.605900 0.560459 0.513365
FRANCE 1.114991 0.275900 5.158846 0.000000 0.384311 0.704100 0.573791 0.520514
GERMANY 0.809533 0.426200 9.253901 0.000000 -0.770783 0.448400 0.797453 0.772135
ITALY -0.360389 0.723600 5.424696 0.000100 -1.653120 0.119100 0.678273 0.613927
JAPAN -0.160038 0.874600 11.337730 0.000000 1.664327 0.113400 0.924191 0.911556
UK -1.410826 0.173700 5.056488 0.000100 -1.037861 0.311700 0.591328 0.530027
USA 3.675809 0.001100 10.020550 0.000000 -1.098548 0.282000 0.806403 0.784065

Table 4
Using OLS estimator for Augmented Taylor rule we use equation (2), after estimating OLS by adding
asset price volatility, difference can be noticed with the change in p-value of CPI and for asset volatil-
ity we reject null as all the values of p-value (>0.05). This is an indication that asset volatility is signifi-
cant with adding some extra information to our model taking it to a next step. Concluding that asset
price volatility plays vital role in forming monetary policy. Countries considering nonlinear Taylor
rule are safe as they consider asset volatility while framing monetary policy that countries are less
likely to be affected by the asset volatility other countries will suffer high impact in times of credit
crunch events.
We think that our model might not satisfy assumptions of regression model. We think that there
might be presence of heteroscedasticity, serial correlation and normality of residuals. To go on fur-
ther it might be clear. First we check normality of our model we check by Histogram – Normality
test. We look at value of Jarque-Bera to check normality of the model. Jarque-Bera is calculated as:

IF P-VALUE < 10%, REJECT NULL – Data is not normal

IF P-VALUE > 10%, FAIL TO REJECT NULL – Data is normal

CANADA FRANCE GERMANY ITALY JAPAN UK USA

Jarque-Bera 22.59358 3.660668 0.84406 0.059938 13.10837 2.418072 7.144891
P-value 0.000012 0.16036 0.655714 0.970476 0.001424 0.298485 0.028087
Skewness 1.243361 1.243361 -0.09472 -0.53575 -1.09257 -1.031258 0.564647

Table 5
From above Table 5 we can conclude that Canada, and USA are not normally distributed other coun-
tries have normally distributed data.
After that to check heteroscedasticity we run white test to check where the data is homoscedastic or
not taking null as data is homoscedastic.

16 | P a g e
 CANADA FRANCE GERMANY ITALY JAPAN UK USA
F-stat 0.887128 0.276136 1.44028 0.92599 2.149641 3.909755 0.215685
Obs. R-squared 8.520931 3.396903 11.72225 9.134941 13.57808 17.16904 2.654136
P-value 0.5515 0.9732 0.2433 0.5447 0.1083 0.0114 0.9886
prob. Chi-square 0.4826 0.9465 0.2294 0.4249 0.1381 0.0461 0.9764

Table 6

According to my research, I noticed White’s paper (Halbert White, 1980) is most cited paper which
points out endemic problems. It uses square of residual from regression. As we clearly reject the null
except for UK our residuals are heteroskedastic while residuals for UK are homoscedastic.
After checking residual, as our model is using OLS estimator and time series data there are always
chances of unbiased and consistent and no longer consistent and standard errors are inconsistent so
Serial Correlation LM test will help us figure out if an autocorrelation is an issue in our data. So we
test with Breusch-Godfrey Test in E-views with H0: No serial correlation; and get following results:

Serial Correlation Test Results with upto 1 lags

CANADA FRANCE GERMANY ITALY JAPAN UK USA
F-stat 22.41337 19.01164 7.50480 1.50510 4.05720 30.08495 1.62471
Obs.*R-squared 14.51485 12.67091 6.88857 1.84436 4.23886 14.70998 1.83068
P-value 0.00010 0.00020 0.01170 0.24010 0.06010 0.00000 0.21420
prob. Chi-square 0.00010 0.00040 0.00870 0.17440 0.03950 0.00010 0.17600
Durbin Watson Stat. 1.225227 1.454056 0.803877 1.109911 1.251211 1.662271 0.452235

Table 7

Above (table 7) indicates that we should reject the null for Canada, France, Germany, and UK and we
fail to reject Italy, Japan and USA. It concludes that out of 7, 4 countries data have autocorrelation.
Our time series data is quarterly as we have taken 1 lag that is equal to 4 months i.e. delay of 4
months with 1 lag included. This autocorrelation can be useful in our model as it is depended on one
other. As we are looking for the effects of monetary policy on stock prices.
So far, we have estimated our model with the help of Taylor rule and Augmented Taylor rule. I want
to expand my research a bit more by re-estimating our model with the help of GMM (Generalized
moments of movements).
Going a bit further re-estimating model we use the historical data including lag to instruments data
output and inflation (with 2 lags). “According to Hayashi (2000, points out p.215), is outweighing ma-
trix Sˆ at the core of efficient GMM is a function of fourth moments, and obtaining reasonable esti-
mates of fourth moments may require very large sample” (Christopher F Baum, Stata Journal, 2003,

17 | P a g e
3-1, 1-31). The significance is that the effective GMM estimator can have deprived sample proper-
ties. GMM estimator is used when we don’t know the distribution of dependent variable this
method suits our model well and GMM is more efficient when heteroscedasticity is present. GMM
includes OLS and 2SLS (which is a special case of GMM). This is like OLS estimator.

After availing the regression in the e-views with the instruments (inflation and output with 2 lags).
We get the following results (Table 8 and 9).

GMM Estimator results

INSTRUMENTS(Inflation and output upto 2 lags)
P-value CANADA FRANCE GERMANY ITALY JAPAN UK USA
cpi 0.65380 0.67450 0.64000 0.51050 0.22530 0.82390 0.88320
outputgap 0.50210 0.67130 0.70680 0.32800 0.00050 0.79320 0.69950
s 0.02200 0.76550 0.93420 0.44500 0.24490 0.71490 0.67130
J-stats 0.31362 0.30435 0.81767 0.34081 0.49625 0.95986 0.96301

Table 8
The above (Table 8) represents the p-value of the following variables used in the GMM estimator
with instrument variables. It says that for Canada its p-value for S (asset price volatility) is significant,
which means it affects interest rates directly. For other countries p-value of S are insignificant to
which it affects indirectly.

GMM Estimator results

Co-efficients CANADA FRANCE GERMANY ITALY JAPAN UK USA
Inflation -3.42705 -0.11191 -2.81440 -2.42685 -4.84679 1.29946 1.48988
Outputgap 0.37001 0.33217 0.90636 1.03534 0.78352 2.95705 -0.76622
S 0.00666 0.00236 -0.00066 -0.00582 0.00215 0.00508 0.00803

Table 9
Co-efficient gives an idea about with 1% rise in independent variable (asset price volatility) it will in-
fluence dependent variable (GDP) by the value of coefficient. The above (Table 9), says Germany and

18 | P a g e
Italy has negative impact of asset price volatility on GDP whilst on other countries GDP is influenced
positively.

GMM ESTIMATOR Results interpretetion.

Impact > Positive Negative Direct Indirect
CANADA Y - Y -
FRANCE Y - - Y
GERMANY - Y - Y
ITALY - Y - Y
JAPAN Y - - Y
UK Y - - Y
USA Y - - Y

Table 10
This table shows the impact of volatility (Independent variable) on GDP (Dependent variable)
NOTE: GMM estimator instruments are all supportive as per J-statistics (p-value) as it is greater than
(.05)

RELATIONSHIP BETWEEN MONETARY POLICY AND MARKET VOLATILITY

COUNTRY CANADA FRANCE GERMANY ITALY JAPAN UK USA
RELATIONSHIP Direct Indirect Indirect Indirect Indirect Indirect Indirect
IMPACT Positive Positive Negative Negative Positive Positive Positive

Table 11
Considering statistical data got by the test, (Table 10) tells us about the GMM estimator results (Ta-
ble 8 and Table 9). We can conclude that Canada has a positive and direct influence while Germany
and Italy have a negative and indirect impact on interest rate and except Canada, Germany and Italy
other countries has positive and negative on interest rates.

19 | P a g e
COMMENTS ON RESULTS
As this research investigates if there exists relationship between monetary policy and market volatil-
ity. We follow Taylor rule in our model taking GDP as dependent variable and CPI (inflation) and
other variables (inflation and output gap) as independent variables. With OLS estimator we estimate
an equation and get to know from results that 5 out of 7 CPI (Canada, France, Italy, Japan, and USA)
has its influence on GDP while others are not. Taylor rule says that inflation and output have equal
weightage in shaping monetary policy, when we try the same checking whether they have similar
weightage we found results are significant and they perform an individual role when considered
monetary policy. Our model has time-series data (1999: Q1 – 20107: Q2), there is a doubt of having
some shocks effects. To check that, we performed multiple-breakpoint test from which we came to
know that our model has some shock effects (maybe Dotcom bubble (2000) or Financial crisis (2008)
or other) and has about 3 downturns which are to be taken into consideration in our model are al-
ready there.
To extend our research we use augmented Taylor rule to which other variable can be added and
bring some variability to conventional Taylor rule. Adding asset price volatility to our Taylor rule esti-
mated before, impact of volatility can be noticed with the change in p-value of augmented Taylor
rule. Output gap has no influence as before, but Canada’s GDP was influenced by inflation before but
not now other than that other countries GDP is influenced by inflation. Whilst with this considering
p-value for asset price volatility our results are highly insignificant which indicates a strong bond be-
tween volatility and GDP. There always come doubt with time-series data as it might suffer from se-
rial correlation and heteroscedasticity of residuals, so we carry out some checks. We realize that our
data is heteroskedastic and serially correlated for Canada, France, Germany, Japan and UK and there
is no correlation present for USA and Italy.
We now know that our model suffers from heteroscedasticity and serial correlation, to overcome
this issue we now use GMM estimator (Generalized method of moments) by implementing IV proce-
dure. This is main part of research and tells us about kind of relationship that is present among the
variables. So implementing GMM estimator with instrument variables (output and inflation both
with 2 lags) on augmented Taylor rule. P-value associated to J-statistic supports our choice of instru-
ments, considering coefficient results we notice that our results are highly significant and indicates
that asset price volatility has high impact on the GDP. Having a look at (Table 10), we tend to get a
glance of how independent variable influence dependent variables.

20 | P a g e
CONCLUSION
In a nutshell, with increasing globalization domestic markets have been integrating with other na-
tions markets. Making them come across various other factors that other markets are exposed to,
passing risk factors from one to another tends to make market come across undetermined circum-
stances. After financial crisis (2008), financial instability is a growing concern which need to be re-
sponded to as soon as possible. Somehow central banks are managing to tackle instability of market
with the help of interest rate (Woodford, 2012).
Conventional traditional rule has inflation and output as its variable which means it doesn’t add vari-
ability of instability of market to model, which needs to be taken care as of now in 2018. There is no
doubt about inflation and output being primary concerns of central banks (Blanchard et al., 2010).
Another common point is that financial instability should not be responded without a thought or
else can be at its worst. Before responding to these types of event, relationship between actions and
instability should be known first. There have been many measures taken to incorporate various vari-
ables to traditional Taylor rule (1993). This can be noted that some of the countries among G7 uses
non-linear Taylor rule (Augmented Taylor rule) i.e., Eurozone (France, Germany, and Italy) and UK.
While USA (Fed) uses linear Taylor rule, but now they have switched.
Our aim of study is fulfilled with GMM estimator determining the relationship between monetary
policy and market volatility. We can get a glimpse of that looking at (Table 10 & 11). Canada has a
direct relationship between variables and has positive impact while other (France, Germany, Italy,
Japan, UK, and USA) has indirect relationship which has positive impact other than Germany and It-
aly has negative relationship.
With my viewpoint there is lot more that central banks need to consider as all the economies consid-
ered are open economy inviting more volatility to them. As nowadays lot of things are going on in
the market considering the new instruments coming up in the market, they are continuously adding
volatility to market which are to be handled with care. Recently noticed cryptocurrency bubble
crash is a good example for the volatility prevailing in market. Nowadays, trading is in limelight
many individuals to gain financial independence they get involved in trading activities adding some
more volatility to prevailing market situations influencing upshift in the market. If considered current
situation of financial markets, we are in the same situation as it was before the financial crisis, con-
centration of more debts (because of hybrid instruments used nowadays in financial markets) or can
say we are almost near to next recession if not taken care. Simple Taylor rule doesn’t help overcome
this problem, but augmented Taylor rule can so it’s better if that is used.

21 | P a g e
However, we can conclude, the countries considering (augmented Taylor rule) economic shocks and
downturns are more likely to have reduced instability rather than the countries not considering (Tay-
lor rule). Using linear Taylor rule can lead to accumulating uncertainty in the economy with time and
can bring huge losses (like financial crisis, 2008). Thus, counsel with respect to financial policy ought
to be based not exclusively on characterization of the economy, but or maybe on a few elective per-
spectives. Taylor rule (1993), can be said was probably followed by many nations until 2000 (before
many economies were closed economy), but to safeguard their economies they switched to non-lin-
ear Taylor rule to avoid instability (as they were open economy and knew the consequences). Re-
cently, USA has started following like Japan’s method to frame monetary policy since crisis 2008 (The
Japanese Taylor rule estimated using censored quantile regressions)” (Chen, Jau-er, and Masanori
Kashiwagi. “The Japanese Taylor Rule Estimated Using Censored Quantile Regressions.” Empirical
Economics (2016)). This shows that countries following linear Taylor are realizing that volatility is an
important variable which should be considered in monetary policy to stabilize the economy.

Thus, we can say thay Taylor rule was more effective to closed economies which hardly exists now.
In contrast, in current situation most of the economies are open economies which are coming across
more and more challenges every day. With increasing volatility in market it must be one of the main
objectives of the central banks to control it through monetary policy and stabilize the economy con-
sidering other variables. Monetary policy is the main tool of central banks which help them regulate
market as desired by the nation central bank which helps them fulfil their objectives.

22 | P a g e
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 APPENDIX
RESULTS OF OLS (LINEAR TAYLOR RULE)

CANADA FRANCE GER- ITALY JAPAN UK USA

MANY
R-SQUARED 0.78237 0.74100 0.89034 0.74781 0.94729 0.80179 0.77570
ADJUSTED R-SQUARED 0.77640 0.73391 0.88733 0.74091 0.94585 0.79636 0.76955
S.E. OF REGRESSION 0.30061 0.24786 0.27872 0.36141 0.23946 0.27298 0.29352
SUM SQUARED RESID 6.59672 4.48483 5.67091 9.53498 4.18586 5.43983 6.28916
LOG LIKELIHOOD -14.96121 -0.29806 -9.21473 -28.96020 2.32346 -7.63387 -13.14691
F-STATISTIC 131.21280 104.42800 296.33210 108.23460 656.00500 147.64840 126.22540
PROB(F-STATISTIC) 0.00000 0.00000 0.00000 0.00000 0.00000 0.00000 0.00000
MEAN DEPENDENT VAR 0.57289 0.37008 0.36370 0.11514 0.22311 0.46744 0.50880
S.D. DEPENDENT VAR 0.63573 0.48050 0.83035 0.71002 1.02903 0.60492 0.61143
AKAIKE INFO CRITERION 0.47266 0.08679 0.32144 0.84106 0.01780 0.27984 0.42492
SCHWARZ CRITERION 0.56467 0.17879 0.41344 0.93306 0.10981 0.37184 0.51692
HANNAN-QUINN CRITER. 0.50943 0.12356 0.35821 0.87783 0.05457 0.31661 0.46169
DURBIN-WATSON STAT 0.07304 0.10761 0.18619 0.04743 0.07762 0.07973 0.07554
Table (a)

RESULTS FOR OLS (NON-LINEAR TAYLOR RULE)

CANADA FRANCE GERMANY ITALY JAPAN UK USA
R-SQUARED 0.560459 0.573791 0.797453 0.678273 0.924191 0.591328 0.806403
ADJUSTED R-SQUARED 0.513365 0.520514 0.772135 0.613927 0.911556 0.530027 0.784065
S.E. OF REGRESSION 0.304653 0.246763 0.237509 0.335051 0.233819 0.267107 0.182966
SUM SQUARED RESID 2.598782 1.461412 1.353848 1.683885 0.984081 1.426926 0.870391
LOG LIKELIHOOD -5.23494 1.608937 2.679276 -3.938144 2.961338 -0.184151 10.532
F-STATISTIC 11.90093 10.77012 31.49703 10.54112 73.14618 9.646333 36.09992
PROB(F-STATISTIC) 0.000033 0.000113 0 0.000555 0 0.000381 0
MEAN DEPENDENT VAR 0.708378 0.430525 0.46265 0.330811 0.107852 0.586708 0.5315
S.D. DEPENDENT VAR 0.436721 0.356363 0.497554 0.539232 0.786222 0.389627 0.39374
AKAIKE INFO CRITERION 0.577184 0.17079 0.094337 0.835594 0.094424 0.348679 -0.435467

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 SCHWARZ CRITERION 0.760401 0.361105 0.284652 1.034423 0.292795 0.545022 -0.24864
HANNAN-QUINN CRITER. 0.637915 0.228971 0.152519 0.869244 0.141154 0.400769 -0.375699
DURBIN-WATSON STAT 0.202095 0.120244 0.152198 0.725695 0.425897 0.292763 0.2418
Table (b)

RESULTS OF GMM ESTIMATOR (INSTRUMENTS= INFLATION AND OUTPUT WITH 2 LAGS)

CANADA FRANCE GERMANY ITALY JAPAN UK USA

R-SQUARED -0.531726 -0.429444 -0.733214 -0.433497 0.667477 -5.56775 -4.121693
ADJUSTED R-SQUARED -0.695839 -0.608124 -0.949866 -0.720197 0.612057 -6.552913 -4.712658
S.E. OF REGRESSION 0.568718 0.451911 0.694773 0.707237 0.489699 1.070796 0.941084
DURBIN-WATSON STAT 2.134485 1.276584 0.514945 3.346841 1.332916 1.162286 1.788788
INSTRUMENT RANK 5 5 5 5 5 5 5
MEAN DEPENDENT VAR 0.708378 0.430525 0.46265 0.330811 0.107852 0.586708 0.5315
S.D. DEPENDENT VAR 0.436721 0.356363 0.497554 0.539232 0.786222 0.389627 0.39374
SUM SQUARED RESID 9.05631 4.901363 11.58501 7.502768 4.316489 22.93207 23.0266
J-STATISTIC 1.015384 1.05506 0.053153 0.907395 0.462959 0.002533 0.002151
PROB(J-STATISTIC) 0.313616 0.304345 0.817665 0.340807 0.496245 0.95986 0.96301
Table (c)

Coefficient Std. Error t-Statistic Prob.

CANADA 1.672843 1.673254 0.999754 0.3207
FRANCE -1.33717 1.306429 -1.023533 0.3094
GERMANY -3.78301 1.570613 -2.408618 0.0185
ITALY -2.3327 1.508608 -1.546262 0.1264
JAPAN -1.59086 1.022501 -1.555856 0.1241
UK -7.38553 1.241982 -5.946565 0

` USA 0.034737 1.061212 0.032733 0.974

Table 1 (values for CPI)

Wald Test (H0: β = 0.5, γ = 0.5)

CANADA FRANCE GERMANY ITALY JAPAN UK USA
F-STAT 26.4155 31.69217 76.70719 57.32948 155.1008 41.627 25.23272
CHI SQUARE 79.2465 95.07652 230.1216 171.9884 465.3024 124.881 75.69815
P-VALUE 0.00000 0.00000 0.00000 0.00000 0.00000 0.00000 0.00000

Table 2

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 Multiple Break Point Test Result (F-STAT)
BREAKS CANADA FRANCE GERMANY ITALY JAPAN UK USA
0 vs. 1 31.0401 37.5975 67.49881 67.49881 15.72972 20.29724 14.48172
1 vs. 2 5.632835 16.28832 11.89336 11.89336 13.34571 10.85825 34.48018
2 vs. 3 46.5918 9.172984 18.7446 18.7446 8.76507 20.15643 8.309325
3 vs. 4 2.458694 6.478214 2.575623 2.575623 4.832915 3.377797 1.655953
4 vs. 5 - 0 - - - - -

Table 3

CPI OUTPUTGAP ASSET VOLATILITY G7

T-Stat P-value T-Stat P-value T-Stat P-value R-sqd. Adj. R-sqd.
CANADA 3.486011 0.001600 5.654564 0.000000 -0.521753 0.605900 0.560459 0.513365
FRANCE 1.114991 0.275900 5.158846 0.000000 0.384311 0.704100 0.573791 0.520514
GERMANY 0.809533 0.426200 9.253901 0.000000 -0.770783 0.448400 0.797453 0.772135
ITALY -0.360389 0.723600 5.424696 0.000100 -1.653120 0.119100 0.678273 0.613927
JAPAN -0.160038 0.874600 11.337730 0.000000 1.664327 0.113400 0.924191 0.911556
UK -1.410826 0.173700 5.056488 0.000100 -1.037861 0.311700 0.591328 0.530027
USA 3.675809 0.001100 10.020550 0.000000 -1.098548 0.282000 0.806403 0.784065

Table 4

CANADA FRANCE GERMANY ITALY JAPAN UK USA

Jarque-Bera 22.59358 3.660668 0.84406 0.059938 13.10837 2.418072 7.144891
P-value 0.000012 0.16036 0.655714 0.970476 0.001424 0.298485 0.028087
Skewness 1.243361 1.243361 -0.09472 -0.53575 -1.09257 -1.031258 0.564647

Table 5

CANADA FRANCE GERMANY ITALY JAPAN UK USA

F-stat 0.887128 0.276136 1.44028 0.92599 2.149641 3.909755 0.215685
Obs. R-squared 8.520931 3.396903 11.72225 9.134941 13.57808 17.16904 2.654136
P-value 0.5515 0.9732 0.2433 0.5447 0.1083 0.0114 0.9886
prob. Chi-square 0.4826 0.9465 0.2294 0.4249 0.1381 0.0461 0.9764

Table 6

Serial Correlation Test Results with upto 1 lags

CANADA FRANCE GERMANY ITALY JAPAN UK USA
F-stat 22.41337 19.01164 7.50480 1.50510 4.05720 30.08495 1.62471
Obs.*R-squared 14.51485 12.67091 6.88857 1.84436 4.23886 14.70998 1.83068
P-value 0.00010 0.00020 0.01170 0.24010 0.06010 0.00000 0.21420
prob. Chi-square 0.00010 0.00040 0.00870 0.17440 0.03950 0.00010 0.17600
Durbin Watson Stat. 1.225227 1.454056 0.803877 1.109911 1.251211 1.662271 0.452235

Table 7

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 GMM Estimator results
INSTRUMENTS(Inflation and output upto 2 lags)
P-value CANADA FRANCE GERMANY ITALY JAPAN UK USA
cpi 0.65380 0.67450 0.64000 0.51050 0.22530 0.82390 0.88320
outputgap 0.50210 0.67130 0.70680 0.32800 0.00050 0.79320 0.69950
s 0.02200 0.76550 0.93420 0.44500 0.24490 0.71490 0.67130
J-stats 0.31362 0.30435 0.81767 0.34081 0.49625 0.95986 0.96301

Table 8

GMM Estimator results

Co-efficients CANADA FRANCE GERMANY ITALY JAPAN UK USA
Inflation -3.42705 -0.11191 -2.81440 -2.42685 -4.84679 1.29946 1.48988
Outputgap 0.37001 0.33217 0.90636 1.03534 0.78352 2.95705 -0.76622
S 0.00666 0.00236 -0.00066 -0.00582 0.00215 0.00508 0.00803

Table 9

GMM ESTIMATOR Results interpretetion.

Impact > Positive Negative Direct Indirect
CANADA Y - Y -
FRANCE Y - - Y
GERMANY - Y - Y
ITALY - Y - Y
JAPAN Y - - Y
UK Y - - Y
USA Y - - Y

Table 10

RELATIONSHIP BETWEEN MONETARY POLICY AND MARKET VOLATILITY

COUNTRY CANADA FRANCE GERMANY ITALY JAPAN UK USA
RELATIONSHIP Direct Indirect Indirect Indirect Indirect Indirect Indirect
IMPACT Positive Positive Negative Negative Positive Positive Positive

Table 11
Figures for simple Taylor rule:

Figure 1(Canada)

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 Figure 2 (France)

Figure 3 (Germany)

Figure 4 (Italy

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 Figure 5 (Japan)

Figure 6 (UK)

Figure 7 (USA)

Figures of re-estimated model:

Figure 8 (Canada)

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 Figure 9 (France)

Figure 10 (Germany)

Figure 11(Italy)

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 Figure 12 (japan)

Figure 13 (UK)

Figure 14 (USA)

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