The Correlation of Monetary Policy, Inflation and Stock Returns During Periods of Inflation and Deflation

This paper examines the debated issue of the existence of a relationship between a country’s monetary policy and the relative stock market and stock returns. Specifically, the paper examines the affect and correlation of overnight interest rate (known as federal funds rate in U.S.), inflationary rate and stock returns on and with each other, respectively, during periods of inflation and deflation. The deflationary period investigated is the period of deflation in Japan and the inflationary period examined is over the last decade in the United States. The analysis is performed using multivariate VAR/VEC co-integrating specifications to supplement the results from the Granger-causality test. In addition, this paper contributes to the topic by comparing the effectiveness of both central banks use of policy instruments during these recent periods and whether both countries could have implemented different policies to better combat the macroeconomic problems in their country at the time, in order to provide future insight