The Impact of Monetary policy on Stock Market Performance

Abstract

This work takes a comprehensive look at the monetary policy and stock market dynamics from the African perspective, using five indicators namely; S&P global equity indices, inflation rate, money and quasi growth (M2), real interest rate and GDP growth in a panel VAR model. The panel VAR approach addresses the endogeneity problem by allowing the endogenous interaction between the variables in the system of equations. The study models the dynamic relationship in the system of panel VAR equations with data from 1979:2013, performing cross-sectional dependence, unit-root and cointegration tests, and thus estimated the contemporaneous regression model. The study established that, the stock markets of the 12 African countries are positively affected contemporaneously by their respective monetary policies through the interest rate channel, but could not find evidence to the reverse reaction.

The study then estimated impulse response functions and thus established that both money supply and real interest rate decline in response to positive and negative stock market shocks respectively, whiles inflation responds positively to a negative stock market shock. Using the forecast error variance decompositions (fevds), we establish that between the two monetary policy stances considered (money supply and real interest rate), real interest rate has the greatest influence on the stock market and inflation. Conversely, the stock market turns to exert greater influence on real interest rate than it does on money supply, therefore indicating a reverse relationship between monetary policy and the stock market. Similar reverse relationships among the other variables have been observed. This in the estimation of the researchers is enough evidence to conclude that there is a bidirectional relationship between monetary policy and stock market performance.

In conclusion, our results confirm the economic theories and empirics that there are complicated and significant relationships between monetary policy and stock market performance and that the relationship is bidirectional.