Stock Price Volatility And Monetary Policy

The relationship between stock price and monetary policy has been concentrated for a long time. We have two major issues here. One is the transmission mechanism of stock market, and the other is how monetary policy should respond to stock price volatility.On the transmission mechanisms, Mishkin (2000) thought Tobin's q effects, firm balance-sheet effects, household liquidity effects and household wealth effects were the major four transmission mechanisms of asset prices to real economy. The empirical studies of Tobin's q effects from micro and macro are abhorrent, and the household wealth effects are proved. However, in China, studies on asset prices, especially on the transmission mechanism of stock market are insufficient. On the monetary policy's response to stock price volatility, three major opinions are quiet mature, but we can not apply any one of them to Chinese occasion before ascertaining the transmission mechanisms.Based on the abundant studies both home and aboard, this paper proves the transmission mechanisms of Chinese stock market through econometric approaches, analyzes the deep reasons and the implication to monetary policy choice, and then gives some suggestions on Chinese policy making.Different from former researches, this paper uses VAR model, Impulse Response Function and Variance Decomposition to analyze stock market's transmission mechanisms, mainly focusing on investment and consumption. Besides, to observe the near five years' development of Chinese stock market, this paper has made stability test.On the investment, the empirical tests prove that the impact of stock market to investment is positive, but is weak compared to foreign cases with an impact coefficient of only 0.14. The stability test shows that this impact became stronger since Jan. 2006. These indicate that Chinese stock market is growing and the transmission is becoming stronger, yet weak compared to developed countries. These are mainly caused by three factors: (1)the finite depth and scope of Chinese stock market; (2)the government's overall interference; (3)the marked noise effect.On the consumption, both the direct and indirect impacts are proved existed but weak, especially while the high-going real estate price, which burdens people's living cost. This paper concludes out four reasons: (1)the insufficient residents' investment on stock market; (2)the absurd constructions of investors and benefits distribution; (3)squeeze effects; (4) the marked noise effect.Traditional monetary policy has four terminal targets: price stability, sufficient employment, economy development and balance of international payment. The central bank will fulfill these four targets through controlling intermediate targets. Taylor's rule indicates that when real economy departures the equilibrium, the FED will control interest rate slimly to make real economy revert back to the equilibrium. Then if the central bank wants to include stock price into monetary policy deciding function, two factors should be fulfilled: (1)stock price volatility has a great impact to real economy; (2)if the central bank adjusts monetary policy according to traditional rules, the impact can not be eliminated. According to this paper's empirical studies, the first factor has not been satisfied, so there is no reason for the central bank to include stock price into policy making process.However, the central bank should not ignore the impact and impulse of stock price volatility to finance stability, so this paper suggests that although monetary policy need not respond to stock price volatility directly, the central bank should pay attention to excessive volatility, which may indicate some important inflation information. In addition, the construction of Chinese stock market regulations and rules is strongly suggested to make Chinese stock market to play its role in future economy, while the scope of stock market should be enlarged.