Working Papers, Federal Reserve Bank of Boston 15-15
After a long period of loose monetary policy triggered by the Great Recession, some central banks are signaling that they will raise their policy rates soon. Previous research, for example, Bernanke and Kuttner (2005) and Ozdagli (2014), has shown that asset prices react more strongly to monetary policy target surprises on the dates of such a policy reversal announcement. However, we know very little about whether the cross-sectional differences among firms and sectors play a significant role in transmitting a reversal decision to the economy. First, this paper provides evidence that the financial health or industry of a firm does not seem to play an economically significant role in the differential reaction of stock prices to monetary policy on reversal dates. Therefore, when contemplating a liftoff decision, which is a reversal of a loose monetary policy, a monetary authority does not need to consider credit allocation or weakness in the financial sector as a greater concern than it considers these issues when contemplating a rate change decision that is not a reversal. Second, the paper notes that, since the 1990s, each reversal in the direction of monetary policy has been preceded by an extended period of constant interest rates, the wait-for-it (WFI) period. The paper finds that, on the FOMC announcement dates during these WFI periods, stock prices respond more strongly to surprises in the future path of monetary policy than they do on other (non-WFI) non-reversal FOMC announcement days. Moreover, the additional effect of path surprises during the current zero-lower-bound (ZLB) environment closely resembles the effect of the path surprises during the WFI periods in the pre-ZLB environment. Overall, this pattern differs from the results in previous studies, such as Gürkaynak, Sack, and Swanson (2005a) and Ammer, Vega, and Wongswan (2010), that do not find any significant effect on stock prices of path surprises when all FOMC dates are pooled. Combined with the stronger reaction of asset prices to monetary policy on policy reversal dates, this finding lends support to the prediction of previous papers regarding "gradualist" policies: a central bank that adjusts the policy rate slowly can actually lead to a very large reaction to monetary policy, as the market pays closer attention than otherwise to the central bank´s medium- or longer-run interest rate target.