macroeconomic information and stock prices

8/13/2019 Macroeconomic Information and Stock Prices

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J E C O B U S N 1 3 11987; 39:131-140

M a c r o e c o n o m i c n f o r m a t i o n a n d S t o c kP r i c e sG i k a s A H a r d o u v e l is

The paper ana lyzes the re sponse o f s tock pr ices to the announcem ents o f 15 represen ta tivemacroeconomic va r iab les . S tock pr ices re spond pr imar i ly to announcements o f mone ta ryvariables . S tocks of f inancia l com panies are the m ost sens it ive to mon etary news. Implic i t inthe s tock price react ions are the market percept ions that the Federal Reserve plays animpor tan t ro le in fu ture macroeco nom ic deve lopments . The pos t -Oc tober 1982 change in theoperat ing target of the Fede ral R eserve did no t affect the s tock price respo nses subs tantial ly ,a l though i t d id affect the corresponding responses of short - term interes t ra tes .

I I n t r o d u c t i o nMany au thors have ana lyzed the re sponse of s tock pr ices to the weekly announcements o fthe s tock of mo ney , M1. Berkm an 1978), L yng e 1981), C orne l l 1983) , and Pearce andRo ley 1983) f ind that s tock prices respond negat ively to the unanticipated com pon ent of M 1,and that interes t ra tes respond pos i t ively see Co rnel l 1983). The re are two m ajor hypothe sesto expla in these responses . The f i rs t hypothes is Expected R eal Interest Rate) cla ims thats tock prices decrease because the real component of nominal interes t ra tes is expected toincrease . T his affects stock prices both direct ly because the real discount ra te a t which futurecash f lows are capi ta l ized is expected to increase , and indirect ly because real output isadversely affected by higher rea l interes t ra tes and thus future cash f lows are expected todec rease . The second hypothes i s Expected Inflation) cla ims that s tock prices decreasebecause the inf la t ion premium in nominal interes t ra tes increases , which decreases the af tertax rea l d iv idends. 1 The two hypotheses depend , among o the r things , on how marke t spe rce ive fu ture Fed era l R ese rve po l icy and hav e , the re fore , a t t racted a lo t o f a t ten t ion in theliterature.

Pea rce and Roley 1985) ex tend the analys is by examin ing the s tock pr ice reac t ions to m oremacro econom ic announcements : the Federa l d i scount and surcharge ra te , the consum er andthe produ cer p r ice indexes, the unem ploym ent ra te , and the indust ri al p roduc t ion index . The y

A d d r e s s r e p r in t r e q u e s t s t o G i k a s A . H a r d o u v e l i s , D e p a r t m e n t o f E c o n o m i c s , B a r n a r d C o l l e g e , C o l u m b i aU n i v e r s i t y , 3 0 0 9 B r o a d w a y , N e w Y o r k , N e w Y o r k 1 0 0 27 .I w i s h t o th a n k M r . C h a r l e s B u c h w a l t e r o f t h e D a t a R e s o u r c e s In c o r p o r a te d f o r p r o v id i n g a c c e s s t o t h e D R Id a t a b a n k s , M s . K i m R u p e r t o f M o n e y M a r k e t S e r v i c e s I n c o rp o r a t e d f o r p r o v i d i n g s u r v e y da t a , a n d B a r n a r dC o l l e g e ' f o r r e s e a r c h s u p p o r t . T w o a n o n y m o u s r e f e re e s a n d t h e e d i to r , A l a n S e v e r n , h a v e p r o v i d e d u s e f u lc o m m e n t s .S e e P a l m o n a n d Y a a r i ( 1 9 8 1 ) o r F e l d s t e i n ( 1 9 8 0) f o r a n e l a b o r a t e d i s c u s s i o n o n t h e r e l a ti o n s h i p b e t w e e ns t o c k p r i c e s a n d i n f l a t i o n .

Jou rna l o f Econom i cs and Bus i ness 0148-6195 / 87 / 03 .50 1987 Tem pl e Un i ver s i t y


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1 32 G i k a s A . H a r d o u v e l i sf i n d s t a t is t i c a l ly s i g n i f i c a n t n e g a t i v e r e s p o n s e s f o r t h e p r o d u c e r p r i c e i n d e x b e f o r e O c t o b e r1 9 7 9, a n d f o r t h e d i s c o u n t a n d s u r c h a r g e r a t e f r o m O c t o b e r 1 9 79 t o O c t o b e r 1 9 82 . S m i r l o c ka n d Y a w i t z 1 9 8 5 ) f i n d s i m i l a r r e a c t i o n s t o d i s c o u n t r a te c h a n g e s . T h e o v e r a l l c o n c l u s i o na p p e a r s t o b e t h at m o n e t a r y n e w s a f f e c t s t o ck p r i c e s w h i l e n o n m o n e t a r y n e w s d o n o t h a v e a n ys i g n i f i c a n t e f f e c t s .

T h i s p a p e r f o c u s e s o n t h e d is t i n ct i o n b e t w e e n m o n e t a r y a n d n o n m o n e t a r y n e w s a n d o n t h er o l e e x p e c t e d f u t u r e F e d e r a l R e s e r v e b e h a v i o r m a y p l a y b o t h a f t e r m o n e t a r y a n dn o n m o n e t a r y a n n o u n c e m e n t s . I t a l s o a n a l y z e s t h e p e r i o d a f t er O c t o b e r 1 9 82 , w h e n t h eF e d e r a l R e s e r v e s w i t c h e d f r o m n o n - b o r r o w e d r e s e r v e s t o b o r r o w e d r e s e r v e s t a r g e t i n g .H u i z i n g a a n d M i s h k i n 1 9 8 6 ) p r e s e n t e v i d e n c e o f s h i ft s in th e b e h a v i o r o f re a l i n te r e s t r a t e sb o t h a f t e r O c t o b e r 1 9 79 a n d a f t e r O c t o b e r 1 9 82 . I t is i n t e r e s t in g t o r e e x a m i n e t h e i r e v i d e n c eo n i n t e r e s t r a t e s f o r th e p o s t - O c t o b e r 1 9 82 p e r i o d u s i n g a n n o u n c e m e n t e f f e c t s a n d t o e x a m i n ei f a s i m i l a r sh i f t o c c u r s i n s t o c k p r ic e r e a c t i o n s . P r e v i o u s a u t h o r s h a v e r e p o r t e d t h a t a f t e rO c t o b e r 1 9 7 9, i n t e r e s t r a t e s b u t n o t s t o c k p r ic e s ) h a v e s h o w n a s h if t in t h e i r r e a c t i o n tom o n e y a n n o u n c em e n t s .

T h e p a p e r a d d s o n e m o n e t a r y b a n k fr e e r e se r v e s) a n d s e v e n n o n m o n e t a r y v a r i a b l e s ino r d e r t o p r o v i d e a r e p r e s e n t a ti v e se t o f m a c r o e c o n o m i c v a r i a b le s th a t a r e c l o s e l y w a t c h e d b yp r o f e s s i o n a l f o r e c a s t e r s . I t e x a m i n e s t h e r e s p o n s e s o f f o u r r e p r e s e n t a t i v e s t o c k p r i c e i n d e x e sa n d t w o r e p r e s e n t a t i v e i n t e r e s t r a t e s . T h e s t o c k p r i c e i n d e x e s a re : t h e S t a n d a r d a n d P o o r 5 0 0

l a r g e c o m p a n i e s ) , th e A M E X M a j o r M a r k e t i n d e x s m a l l c o m p a n i e s ) , t h e V a l u e L i n e in d e xs m a l l c o m p a n y s t o c k s t r a d e d o u t s id e a m a j o r f i n a n c ia l c e n t er ) , a n d t h e N e w Y o r k S t o c k

E x c h a n g e N Y S E ) F i n a n c i a l i n d e x f i na n c i al c o m p a n i e s ) . A m o n g t h e s t o c k p r i c e i n d e x e s , t h eN Y S E F i n a n c i a l in d e x i s o f s p e c i a l i n te r e st b e c au s e w e e x p e c t m o n e t a r y n e w s t o h a v e a m o r ed i r e c t i m p a c t o n f i n a n c i a l c o m p a n i e s . T h e t w o i n t e r e s t r a t e s a r e t h e t h r e e - m o n t h T r e a s u r y b i l lr a te a n d t h e 2 0 - y e a r T r e a s u r y b o n d r a te . 2

I I D a t a a n d S t a ti st ic a l M e t h o d o l o g yT h e e m p i r i c a l a n a ly s i s is b a s e d o n t h e s t o c k p ri c e r e a c t io n s f r o m t h e m a r k e t c l o s e b e f o r e e a c ha n n o u n c e m e n t t o t h e n e x t m a r k e t c l o s e . T h e e s t i m a t e d e q u at i on s h a v e t h e f o l l o w i n g f o r m :

5D S , = a 0 + ~ aix~ u , . 1 )i

D S t r e p r e s e n t s t h e p e r c e n t a g e c h a n g e i n a s to c k p r i c e i n d e x f r o m t h e m a r k e t c l o s e o fb u s i n e s s d a y t - 1 t o th e m a r k e t c l o s e o f b u s i n e s s d a y t . 3 T h e s u b - i n d e x i ru n s a c r o s s t h e 1 5a n n o u n c e d m a c r o e c o n o m i c v a r i a b l e s , x u i s t h e u n a n t i c ip a t e d c o m p o n e n t o f e c o n o m i c s e r ie slxi, w h i c h i s a n n o u n c e d d u r i n g b u s in e s s d a y t o r a ft e r t h e m a r k e t c l o s e o f b u s in e s s d a y t -

2 If output prices are rigid in the short run b y flexible in the lon g run, then an expected change in the real rateof interest will affect primarily the sho rt-term rate and a change in the inflation prem ium will affect primarilythe long-term rate.3 For the two interest rates, DS, represents the daily change rather than percentage change. Th is mak es theresults comparable to the results of the num erous previous articles. Sm irlock and Yaw itz 1985) argue for usingpercentage changes. O f course, the cho ice has no important bearing on our con clusions sinc e we are primarilyinterested in the algebraic sign o f the reac tions and their statistical significance.


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M a c r o e c o n o m i c I n f o r m a t i o n 1 331 ). I t e q u a l s x~, - x e w h e r e x ~ i s a s u r v e y f o r e c a s t o f th e a n n o u n c e d s e r i e s x i~ . 4 E a c h v e c t o rito f o b s e r v a t i o n s ~ c o n t a i n s z e r o e s f o r th e b u s i n e s s d a y s t h e s e r ie s x i i s n o t a n n o u n c e d .B u s i n e s s d a y s d u r i n g w h i c h n o n e o f t h e 1 5 s e r i e s is a n n o u n c e d a r e n o t p a r t o f t h e s a m p l e , u , ist h e e r r o r t e r m .

I e s t i m a t e E q u a t i o n 1 ) s e p a r a t e l y f o r e a c h s t o c k p r i c e in d e x a n d i n t e re s t r a te u s i n g e r d i n a r yl e a s t - s q u a r e s O L S ) . A l t h o u g h t h e d a i ly c h a n g e s i n t h e v a r i o u s s t o c k p r i c e in d e x e s a r e h i g h l yc o r r e l a t e d , t h e O L S e s t i m a t e s a r e a s e f f i c i e n t a s t h e e s t i m a t e s f r o m a s e e m i n g l y u n r e l a t e dr e g r e s s i o n S U R ) p r o c e d u r e b e c a u s e t h e s e t o f i n d e p e n d e n t v a r i a b l e s is i d e n ti c a l i n e a c he q u a t i o n . H o w e v e r , w h e n e v e r I i m p o s e o r t e s t r e s t ri c t io n s a c r o s s th e d i f f e r e n t e q u a t i o n s a s i nt h e re s u l t s o f T a b l e 3 ) , O L S c e a s e s t o p r o v i d e t h e c o r r e c t s t a n d a r d e r r o r s , a n d t h u s I u s e S U R .

T h e i n t e r e s t ra t e d a t a a r e a n n u a l i z e d y i e l d s to m a t u r i t y a n d r e p r e s e n t m a r k e t r a t e s a s o f 3 : 3 0p . m . E a s t e r n S t a n d a rd T i m e . T h e s t o c k p r i c e d at a a re c lo s i n g p r ic e s 4 : 1 0 p . m . ) . 5 A s am e a s u r e o f e x p e c t a t io n s I u s e d s u r v e y m e d i a n f o r e c a s ts p r o v i d e d b y M o n e y M a r k e t S e r v i c e sI n c o r p o r a t e d . I n H a r d o u v e l i s 1 9 8 5 a ) , I d e s c r ib e i n d e ta i l t h e m a c r o e c o n o m i c a n n o u n c e m e n t sa n d s h o w t h a t t h e s u r v e y m e d i a n s , a l t h o u g h n o t a l w a y s u n b i a s e d o r e f f i c i e n t , f o r e c a s t b e t t e rt h a n p r o x i e s o f e x p e c t a ti o n s w h i c h a r e b a s e d o n a u t o r e g r e s s iv e m o d e l s .

I I I E m p i r ic a l E v i d e n c eT a b l e s 1 a n d 2 c o n t a in t h e e s t i m a t i o n r e s u l ts o f E q u a t i o n 1 ) f o r t h e t i m e p e r i o d s f r o m O c t o b e r1 1, 1 9 7 9 to O c t o b e r 5 , 1 9 8 2 a n d f r o m O c t o b e r 6 , 1 9 8 2 t o A u g u s t 1 6, 1 9 8 4 . 6 T a b l e 2 a l s oc o n t a i n s t e s ts o f s t r u c tu r a l c h a n g e a c r o s s t h e t w o s u b p e r i o d s . 7 T a b l e 3 c o n t a i n s t e s t s o f th eh y p o t h e s i s t h a t th e r e a c t i o n o f N Y S E F i n a n c i a l i n d e x i s t h e s a m e a s th e r e a c t i o n o f th e o t h e rt h r e e i n d e x e s .

A Monetary AnnouncementsM o n e t a r y a n n o u n c e m e n t s h a v e a s i g n i fi c a nt i m p a c t o n s t o c k p ri c e s d u r in g t h e f ir s t s u b p e r i o d ,b u t a m u c h w e a k e r o n e d u r in g t h e s e c o n d s u b p e r io d h y p o t h e s is H 2 ) . H o w e v e r , f o r m a l t e st so f st r u c tu r a l c h a n g e d o n o t s h o w a s i g n i fi c a n t c h a n g e a c r o s s t h e t w o s u b p e r i o d s o b s e r v e th e F

The only exception is announcements of prospective Federal discount and surcharge rate changes, whichare treated as unanticipated. Roley and Troll (1984) provide support ing evidence. However, if some of thesechanges were anticipated, say, because of official sta tements or rumors, our two independent variables wouldsuffer from the usual errors in variables problem which tends to bias them towards zero. Dallas Batten andDaniel Thornton (1984) emphasize that many o f these changes prior to October 1979 reflect technicaladjustments (lagged responses of the Federal Reserve to changing market conditions) and have no informative content.Smirlock and Yawitz (1985) find that reactions to nontechnical adjustments are, indeed, stronger, apparently becausethese coefficients are not biased downward.Announcements which occur between 3:30 p.m. and 4:10 p,m. of business day t fall in unit interval t in thestock price regressions, but in unit interval t + 1 in the interest rate regressions. Thus, the stock price andinterest rate sample sizes are slightly different.6 The observations for MI and free reserves end in January 1984, at the end of the period of lagged reserveaccounting.7 The tests of structural change were calculated using a dummy variable that takes the value of I alter October1982, and multiplying it by each explanatory variable. To allow for the heteroschedasticity of the interest ratesacross the two subperiods, the tests of structural change for the two interest rates do not restrict the errorvariances to be the same across the two subperiods; this was done by performing weighted least-squares withweights equal to one over the standard error of estimate (SEE) of each subperiod. In small samples, thedistribution that I use is more cautious in rejecting the null hypothesi s than the ;~ 2-distribution (see, for example.Theil (1971, p. 402).


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1 3 4 G i k a s A . H a r d o u v e l i s

T a b l e 1 . R e a c t i o n s t o t h e U n a n t i c i p a t e d C o m p o n e n t o f A n n o u n c e d M a c r o e c o n o m i c S e r ie s ( O c t o b e r 1 9 7 9 -O c t o b e r 1 9 8 2 )

N Y S E V a l u e T r e a s u r y T r e a s u r yS & P - 5 0 0 F i n a n ci a l A M E X - M M L i n e B i ll B o n d

C o n s t a n t - 0 . 0 6 0 - 0 . 0 4 0 - 0 . 0 1 0 - 0 . 0 7 2 0 . 0 1 5 0 . 0 0 8( 0 . 0 5 2 ) ( 0 . 0 4 6 ) ( 0 . 0 5 4 ) ( 0 . 0 4 5 ) ( 0 . 0 1 71 ( 0 . 0 0 8 )

M 1 - 0 . 2 0 7 * - 0 . 4 0 2 * * - 0 . 2 7 3 * * - 0 . 2 9 3 * * 0 . 2 1 9 * 0 . 0 9 5 * *( 0 . 1 2 1 ) ( 0 . 1 0 8 ) ( 0 . 1 2 4 ) ( 0 . 1 0 4 ) ( 0 . 0 4 3 ) ( 0 . 0 2 0 )

R E S 0 . 2 7 5 * * 0 . 1 7 6 * 0 . 2 4 0 * * 0 . 2 0 3 * * - 0 . 1 1 5 * - 0 . 0 2 2( 0 . 0 9 1 ) ( 0 . 0 8 2 ) ( 0 . 0 9 4 ) ( 0 . 0 7 9 ) ( 0 . 0 3 21 ( 0 . 0 1 5 )

D I S C - 0 . 7 8 3 * * - 0 . 7 8 7 * * - 0 . 7 6 3 * * - 0 . 6 7 7 * * 0 . 3 7 0 * * 0 . 0 9 0 *( 0 . 3 1 1 ) ( 0 . 2 7 8 ) ( 0 . 3 2 1 ) ( 0 . 2 6 8 ) ( 0 . 1 0 9 ) ( 0 . 0 5 1 )

S U R - 0 . 2 4 6 - 0 . 4 8 0 * * - 0 . 1 5 7 - 0 . 3 9 7 * * 0 . 1 0 8 , 0 . 0 2 0( 0 . 1 8 2 ) ( 0 . 1 6 3 ) ( 0 . 1 8 8 ) ( 0 . 1 5 7 ) ( 0 . 0 6 5 ) ( 0 . 0 3 1 )

C P I 0 . 3 8 5 - 0 . 9 7 3 - 0 . 2 0 3 - 0 . 7 2 5 0 . 0 9 2 0 . 1 9 0( 0 . 6 8 5 ) ( 0 . 6 1 0 ) ( 0 . 7 0 5 ) ( 0 . 5 9 0 ) ( 0 . 2 4 3 ) ( 0 . 1 1 5 )

P P I 0 . 4 6 0 - 0 . 6 2 9 - 0 . 3 3 2 - 0 . 4 2 6 0 . 2 9 4 0 . 2 9 5 * *( 0 . 5 3 3 ) ( 0 . 4 7 5 ) ( 0 . 5 4 8 ) ( 0 . 4 5 9 ) ( 0 . 1 8 9 ) ( 0 . 0 8 9 )

U N 0 . 1 2 9 - 0 . 1 2 3 0 . 1 3 6 - 0 . 3 1 2 - 0 . 5 7 7 * * - 0 . 0 9 4( 0 . 7 1 4 ) ( 0 . 6 3 6 ) ( 0 . 7 3 5 ) ( 0 . 6 1 5 ) ( 0 . 2 5 3 ) ( 0 . 1 2 0 )

I P 0 . 1 4 6 0 . 1 1 1 0 . 0 9 2 0 . 0 5 4 0 , 0 3 7 0 . 0 5 2( 0 . 2 0 9 ) ( 0 . 1 8 7 ) ( 0 , 2 1 6 ) ( 0 . 1 8 0 ) ( 0 . 0 7 4 ) ( 0 . 0 3 5 )

P I 0 . 5 3 9 0 . 6 5 9 * * 0 . 7 8 2 * * 0 . 5 1 6 - 0 . 2 3 2 * - 0 . 1 7 9 *( 0 . 3 6 2 ) ( 0 . 3 2 2 ) ( 0 . 3 7 2 ) ( 0 . 3 1 2 ) ( 0 . 1 2 8 ) (0 .(K :~ 0)D G 0 . 0 2 5 0 . 0 0 1 0 . 0 2 0 0 . 0 2 4 0 . 2 1 4 - 0 . 0 0 3( 0 . 0 4 7 ) ( 0 . 0 4 2 ) ( 0 . 0 4 8 ) ( 0 . 0 4 0 ) ( 0 . 1 6 6 ) ( 0 . 0 0 8 )

L I - 0 . 1 8 9 0 . 0 2 3 - 0 . 0 9 8 0 . 0 1 9 - 0 . 0 9 6 0 . 0 0 3( 0 . 1 8 2 ) ( 0 . 1 6 2 ) ( 0 . 1 8 7 ) ( 0 . 1 5 7 ) ( 0 . 0 6 4 ) ( 0 . 0 3 0 )

C C - 0 . 0 1 8 0 . 0 3 9 - 0 . 1 0 6 - 0 . 0 8 1 - 0 . 0 5 3 - 0 . 0 2 1( 0 . 2 1 4 ) ( 0 . 1 9 1 ) ( 0 . 2 2 0 ) ( 0 . 1 8 4 ) ( 0 . 0 7 5 1 ( 0 . ( /3 5 )

R S - 0 . 0 9 8 - 0 . 1 6 2 - 0 . 2 2 6 - 0 . 1 7 4 0 , 0 6 0 0 . 0 2 8( 0 . 3 5 0 ) ( 0 . 3 1 2 ) ( 0 . 3 6 0 ) ( 0 . 3 0 1 ) ( 0 . 0 4 2 ) ( 0 .( 1 20 )

H S 1 . 3 3 0 . 9 1 5 1 . 5 4 1 . 7 0 0 . 9 9 2 * 0 .1 19 3( 1 . 4 4 ) ( 1 . 2 9 ) ( 1 . 4 9 ) ( 1 . 2 4 ) ( 0 . 5 1 1 ) ( 0 . 2 4 2 )

T D 0 . 2 2 2 0 . 3 2 3 * * 0 . 2 8 6 * 0 . 2 7 0 * - 0 . 0 9 4 * * - 0 . 0 2 1( 0 . 1 6 5 ) ( 0 . 1 4 7 ) ( 0 . 1 6 9 ) ( 0 . 1 4 2 ) ( 0 . 0 3 5 ) ( 0 . 0 1 6 )

R 2 0 . 0 4 6 0 . 1 0 3 0 , 0 4 0 0 . 0 7 6 0 . 1 6 0 0 . 0 8 9S E E 0 . 9 7 0 . 8 7 1 . 0 0 0 . 8 4 0 . 3 4 0 . 1 6H I : F ( 1 5 , N - 1 6 ) 2 . 1 6 * 3 . 7 6 * * 2 . 0 0 * * 2 . 9 8 * * 6 . 1 6 * 3 . 6 5 * *I4_2: F ( 4 , N - 1 6 ) 6 . 4 1 * 1 1 . 6 3 * 5 . 6 7 * * 9 . 0 1 * 1 7 . 4 6 * 4 . 9 7 * *H 3 : F ( 1 1 , N - 1 6 ) 0 . 7 5 1 . 3 2 0 . 9 4 1 . 07 2 . 6 2 * * 1 . 53

Notes (a) Standard err ors are in the parentheses. Double asterisk (**) denotes statistical significance at the 95 % level, an d single asterisk (*) at the90% level , /~ 2 is the coeff ic ient of determinat ion adjusted f or degrees o f freedom. SEE is the regression s tandard e rror . HI is the hypothesis that a l ls lope coeff ic ients are zero; H 2 is s imilar for M1 , R ES, DISC, and SU R; an d H3 fo r the other e leven coeffic ients . (b) The dependent variables are %cha nge in the Standard an d Poo r 500 , the New Y ork Stock Exchan ge Financial index, the AM EX M ajor Market index, the Value Line index, and thecha nge in the three-month Trea sury bi l l and 20- year Treasury bond yields to maturity . (c) The independent variables are: M I (% change); f ree reserves(% o f non-bo rrow ed reserves); F ederal discount ra te and surch arge rate (change); consu me r price index and pro duce r price index (% change);unemployment ra te ( level); industr ia l production index, personal income, durable g oods , index of leading indicators (% change); co nsum er credi t(ch ang e in $ billions); retail sales (% change); hou sing starts (millions of units); and trad e deficit ($ billions). All nonmo netary series are mo nthly, M 1and RES are wee kly; DISC and S UR are actual (not unantic ipated) changes. (d) Sample s ize N = 362 observat ions fo r the stock indexes, and N =409 fo r Treasury b il l and Treasury bond .


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M a c r o e c o n o m i c I n f o r m a t i o n 1 3 5

T a b l e 2 . R e a c t i o n s t o t h e U n a n t i c ip a t e d C o m p o n e m o f A n n o u n c e d M a c r o e c o n o m i c S e r i e s (O c t o b e r 1 9 8 2 - A u g u s t1 9 8 4 )

D e p e n d e n t V a r i a b l eI n d e p e n de n t N Y S E V a l u e T r e a s u r y T r e a s u r y

V a r i ab l e S & P - 5 0 0 F i n an c i al A M E X - M M L i n e B il l B o n d

C o n s t a n t 0 . 0 2 5 - 0 . 0 2 1 0 . 0 4 1 0 . 0 1 7 0 . 0 0 4 - 0 . 0 0 2( 0 . 0 6 9 ) ( 0 . 0 6 8 ) ( 0 . 0 7 5 ) ( 0 . 0 5 5 ) ( 0 . 0 0 7 ) ( 0 . 0 0 6 )

M I - 0 . 6 9 2 * * - 0 . 6 0 2 * * - 0 . 5 8 9 * * - 0 . 6 7 8 * * 0 . 1 6 3 * 0 . 1 2 9 *( 0 . 2 9 7 ) ( 0 . 2 9 4 ) ( 0 . 3 2 4 ) ( 0 . 2 4 0 ) ( 0 . 0 3 1 ) ( 0 . 0 2 7 )

[ - 1 .4 81 [ - 0 . 7 2 1 [ - 0 . 9 5 ] [ - 1 .3 91 [ - 0 . 7 1 1 [ 1 .2 1 ]R E S 0 . 1 4 3 0 . 1 5 5 0 . 1 7 0 0 . 0 9 3 - 0 . 0 1 3 - 0 . 0 0 5

( 0 . 2 9 7 ) ( 0 . 1 6 9 ) ( 0 . 1 8 6 ) ( 0 . 1 3 8 ) ( 0 . 0 1 8 ) ( 0 . 0 1 5 )[ - 0 .601 [ - 0 .071 1 - 0 .291 [ - 0 551 [ 2 . 6 0 ] [ 0 . 5 9 ]D I S C 0 . 7 0 2 0 . 4 81 1 . 3 0 0 . 6 3 4 0 . 2 6 4 * * 0 . 1 3 6

( 0 . 9 6 9 ) ( 0 . 9 5 8 ) ( I . 0 5 ) ( 0 . 7 8 2 ) ( 0 . 1 0 0 ) ( 0 . 0 8 8 )[ 1 . 4 2 1 [ 1 . 3 4 ] [ 1 . 9 1 ] 1 1 .4 7 ] [ - 0 . 5 3 ] [ 0 . 6 1 ]

S U R . . . . . .C P I 0 . 0 1 l - 0 . 2 6 2 - 0 . 3 3 6 0 . 6 0 2 0 . 0 6 6 0 . 3 5 1 *

( 1 . 8 9 ) ( 1 . 8 7 ) ( 2 . 0 6 ) ( 1 . 5 3 ) ( 0 . 1 9 3 ) ( 0 . 1 7 0 )[ 0 . 3 7 ] [ 0 . 7 0 ] [ 0 . 0 5 ] [ 1 . 0 3 ] [ - 0 . 0 3 ] [ 0 . 2 2 ]

P P I 0 . 3 5 6 - 0 . 5 9 2 - 0 . 0 5 5 - 0 . 2 0 4 0 . 0 6 3 0 . 1 3 5 * *( 0 . 8 5 4 ) ( (3 .8 4 4 ) ( 0 . 9 2 9 ) ( 0 . 6 8 9 ) ( 0 . 0 8 7 ) ( 0 . 0 7 6 )[ 0 . 6 9 ] [ - 0 . 0 4 ] [ 0 . 1 8 ] [ 0 . 1 4 ] 1 - 0 . 9 5 ] [ - 1 . 0 8 ]

U N 1 . 7 9 2 . 3 5 * * 2 . 0 9 * 1 . 7 5 - 0 .2 1 I * * - 0 , 1 8 5 . *( 1 , 0 1 ) ( l . 0 0 ) ( 1 . 1 0 ) ( 0 . 8 1 9 ) ( 0 . 1 0 4 ) ( 0 . 0 9 1 )[1 ,32 ] [2 .161 [ i .49 ] [1 .961 [1 .37 ] [ - 0 .601

I P 0 . 0 9 9 - 0 . 0 5 4 0 . 0 5 9 - 0 , 0 9 8 0 . 0 2 5 - 0 . 0 1 0( 0 . 3 9 5 ) ( 0 . 3 9 1 ) ( 0 . 4 3 0 ) ( 0 . 3 1 9 ) ( 0 . 0 4 0 ) ( 0 . 0 3 5 )

I - 0 . 0 3 ] [ - 0 . 3 7 ] ] - 0 .0 3 ] [ - 0 . 3 2 ] [ - 0 . 1 6 ] [ - 1 .1 5]P [ 0 . 3 6 0 - 0 . 0 2 2 0 . 6 7 0 0 . 1 5 0 0 . 0 7 9 0 . 0 3 1

( 0 . 8 5 9 ) ( 0 . 0 8 5 ) ( 0 . 9 3 4 ) ( 0 . 6 9 3 ) ( 0 . 0 8 8 ) ( 0 . 0 7 7 )[ - 0 . 1 2 ] [ - 0 . 7 8 ] [ - 0 . 0 6 ] [ - 0 . 3 7 ] [ 1.6 2 ] [ 2, 16 ]

D G - 0 . 0 0 2 - 0 . 0 3 4 - 0 , 0 0 2 0 . 0 0 7 0 . 0 1 1 0 . 0 1 6 * *( 0 . 0 8 0 ) ( 0 . 0 8 5 ) ( 0 . 0 8 7 ) ( 0 . 0 6 5 ) ( 0 . 0 0 8 ) ( 0 . 0 0 7 )

[ 0 . 4 1 ] [ - 0 . 7 1 ] [ - 0 . 2 0 ] [ - 0 , 7 0 ] [ - 0 . 5 6 ] [ 1 . 5 9 ]L I 0 . 0 9 8 0 . 1 4 5 0 . 0 1 1 0 . 1 2 5 0 . 0 0 2 0 . 0 0 2

( 0 . 1 1 6 ) ( 0 . 1 1 4 ) ( 0 . 1 2 6 ) ( 0 . 0 9 3 ) ( 0 . 0 1 2 ) ( 0 . 0 1 1 )[ 1 . 4 1 ] [ 0 . 6 5 ] [ 0 . 5 4 ] [ 0 . 6 8 ] [ 1 . 3 6 ] [ - 0 . 0 9 ]

C C - 0 . 1 2 2 - 0 . 1 4 3 - 0 . 1 5 8 - 0 . 1 3 4 0 .0 0 2 0 .0 09( (3 .1 20 ) ( 0 . 1 1 9 ) ( 0 . 1 3 1 ) ( 0 . 0 9 7 ) ( 0 . 0 1 2 ) ( 0 . 0 1 1 )

[ - 0 . 3 4 ] [ - 0 . 8 1 ] [ - 0 . 1 7 ] [ - 0 . 2 0 ] I 0 .5 9 1 [ 0 .6 9 1R S 0 . 1 0 4 - 0 . 0 6 7 0 . 0 7 2 0 . 0 0 3 0 . 0 1 6 0 . 0 1 6

( 0 . 1 8 3 ) ( 0 . 1 8 1 ) ( 0 . 1 9 9 ) ( 0 . 1 4 8 ) ( 0 . 0 1 4 ) ( 0 . 0 1 3 )[ 0 . 5 9 ] [ 0 . 3 0 ] [ 0 . 7 8 ] [ 0 . 6 3 ] [ - 0 . 8 8 ] [ - 0 . 6 0 ]

H S 1 . 6 5 1 . 2 0 1 . 9 5 0 . 8 6 1 - 0 . 0 0 5 0 . 0 1 4( 1 . 1 6 ) ( 1 . 1 5 ) ( 1 . 2 7 ) ( 0 . 9 4 2 ) ( . 1 1 9 ) ( . 1 0 5 )[ 0 . 2 3 ] [ 0 . 1 7 ] [ 0 . 2 4 ] [ - 0 . 4 5 ] [ - 1 . 7 6 ] [ - 0 . 3 7 ]

T D 0 . 1 0 1 0 . 1 4 3 0 . 0 7 2 0 . 1 4 2 - 0 . 0 0 2 0 . 0 0 3( 0 . 2 5 6 ) ( 0 . 2 5 2 ) ( 0 . 2 7 7 ) ( 0 . 2 0 6 ) ( 0 . 0 1 4 ) ( 0 . 0 1 2 )

[ 0 . 3 7 ] [ - 0 . 6 5 1 1 - 0 . 6 7 ] [ - 0 . 4 6 ] [ 2 . 3 1 ] [ 1 . 1 2 ]/ ~ 2 - 0 . 0 0 1 0 . 0 1 0 - 0 . 0 0 4 0 . 0 0 9 0 . 1 1 7 0 . 1 0 0S E E 0 . 9 6 0 . 9 5 1 . 0 5 0 . 7 8 0 , 1 0 0 . 0 9


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1 3 6 G i k a s A H a r d o u v e l i s

a b l e 2 . continued)D e p e n d e n t V a r i a b l e

N Y S E V a l u e T r e a s u r y T r e a s u ryS & P - 5 0 0 F i n a nc i a l A M E X - M M L i n e B il l B o n d

H I : F ( 1 4 , 2 0 7 ) 0 . 9 9 1 .1 5 0 . 9 4 1 . 3 6 3 . 3 0 * * 2 . 9 3 * *H 2 : F ( 3 , 2 0 7 ) 2 . 1 4 1 . 7 2 1 . 7 7 2 . 9 4 * * 1 2 . 4 6 * 8 . 8 2 * *H 3 : F ( 1 1 , 2 0 7 ) 0 . 6 9 1 .0 0 0 . 7 4 0 . 9 4 0 . 8 4 1 .3 7H 1 1 : F ( 1 5 , 5 6 8 ) 0 . 7 0 0 . 6 6 0 . 5 7 0 . 81 1 . 9 6 * 1 . 0 8H 2 2 : F ( 4 , 5 7 9 ) 1 . 48 0 . 6 2 1 . 30 1 . 48 2 . 1 7 * 0 . 8 5H 3 3 : F ( 1 2 , 5 7 2 ) 0 . 4 0 0 . 5 0 0 . 2 4 0 . 5 0 1 . 09 0 . 7 2

Notes: ( a ) S e e n o t e s o f T a b l e 1 . S a m p l e s i z e N = 2 2 2 f o r th e s t o c k p r i c e in d e x e s , a n d N = 2 4 4 f o r t h e t w o i n t e re s t r a te s . ( b ) N u m b e r s i nb r a c k e t s a r e t s t a ti s t ic s t e s ti n g t h e h y p o t h e s i s t h a t t h e c o e f f ic i e n t is e q u a l a c r o s s t h e s u b p e r i o d s O c t o b e r 7 9 - O c t o b e r 8 2 a n d O c t o b e r 8 2A u g u s t 8 4 . H y p o t h e s e s H 1 1 , H 2 2 , H 3 3 a r e n u l l h y p o t h e s e s o f n o s t r u c t u r a l c h a n g e i n a l l c o e f f i ci e n t s , th e c o e f f i c i e n ts o f t h e t h r e e m o n e ta ry ,v a r i a b l e s ( M I , R E S , D I S C ) p l u s t h e c o n s t a n t , a n d t h e c o e f f ic i e n t s o f a l l th e n o n m o n e t a r y v a r i a b l e s p l u s t h e c o n s t a n t a c r o s s t h e t w os u b p e r i o d s . T h e t e s ts o f s t r u c t u r a l c h a n g e f o r T r e a s u r y b i l l a n d T r e a s u r y b o n d d o n o t r e s tr i c t t h e e r r o r v a r i a n c e s t o b e t h e s a m e a c r o s s t h et w o s u b p e r i o d s .

Ta ble 3 . Doe s the New Yo rk Stock Exchange Financial Index Respond D ifferently from the Other StockPrice Indexes? Octob er 1979-A ugust 1984)

I n d e p e n d e n t S i g n i f i c a n c eV a r i a b l e X 2 ( 1 ) L e v e l

M 1 4 . 7 4 * * 0 . 0 2 9R E S 0 . 4 9 0 . 4 8 5

D I S C 0 . 6 6 0 . 4 1 5S U R 4 . 0 5* * 0 . 0 4 4

F o u r M o n e t a r y V a r i a b l e s X 2 (4 ) = 1 0 . 9 6 * ( S i g n if i c a n c e L e v e l = 0 . 0 2 7 )

C P I 2 . 4 9 0 . 1 1 5P P I 2 . 0 0 0 . 1 5 8U N 0 . 6 0 0 . 4 3 8I P 0 . 1 1 0 . 7 3 8P I 0 . 0 2 0 . 8 8 4

D G 3 . 63 * 0 , 0 5 7L I 1 . 2 2 0 . 2 7 0

C C 0 . 1 5 0 . 7 0 2R S 1 . 2 8 0 . 2 5 8H S 0 . 5 5 0 . 4 6 0T D 0 . 6 5 0 . 4 1 9

E l e v e n N o n m o n e t a r y V a r i a b l e s x 2 ( 1 1 ) = 1 2 . 0 7 ( S i g n i fi c a n c e L e v e l = 0 . 3 5 8 )

The sy stem of fou r equations w as est imated u sing the seemingly unrelated regressions procedure, in which the coefficients of eac hexplanatory variable ac ross the S&P-500, AM EX -M M , a nd VL equations w ere restr icted to be the sam e (a total of 32 restr ictions for the15 variables plus the constant term; these restrict ions c anno t be rejected: x2(32) = 40.08 ).


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M a c r o e c o n o m i c I n f o r m a t i o n 1 37s t a ti s ti c o f h y p o t h e s i s H 2 2 i n T a b l e 2 , a s w e l l a s th e t s t a ti s ti c s o f e a c h r e g r e s s i o n c o e f f i c i e n ti n t h e b r a c k e t s) . A s e x p e c t e d , a m o n g t h e f o u r s to c k p r ic e i n d e x e s , t h e N Y S E F i n a n c i a l i n d e xs h o w s t h e s t r o n g e s t r e s p o n s e s t o m o n e t a r y n e w s , w h i c h a r e a l s o s ta t is t ic a l ly d i f f e re n t f r o m t h er e s p o n s e s o f t h e o t h e r t h r e e i n d e x e s .

T h e i n d i v i d u a l s e r ie s r e s u lt s f o r t h e p e r io d O c t o b e r 1 9 7 9 - O c t o b e r 1 9 8 2 a r e s i m i l a r t o th eo n e s f o u n d b y p r e v i o u s a u t h o r s . M 1, t h e d i s c o u n t r at e , a n d t h e s u r c h a r g e r a t e h a v e n e g a t i v ec o e f f i c i e n t s w h i c h a r e s t a t i s t ic a l l y s i g n i f i c a n t . A f t e r O c t o b e r 1 9 8 2 t h e s to c k p r i c e r e s p o n s e s t oM 1 a n n o u n c e m e n t s c o n t i n u e to b e n e g a t iv e a n d a p p e a r s t r o n g e r in m a g n i t u d e , b u t t h e y a r e n o ts t a t is t i c a l ly d i f f e r e n t f r o m t h e f ir s t s u b p e r i o d . T h e s t o c k p r i c e r e s p o n s e s t o th e d i s c o u n t ra t ea n n o u n c e m e n t s s h o w a r e v e r s a l in s ig n a ft e r O c t o b e r 1 9 8 2, b u t th e r e s p o n s e s a r e n o ts t a t is t i c a l ly s i g n i f i c a n t . 8 T h e s u r c h a r g e r a te n e v e r c h a n g e d ( it s t a y e d a t z e r o ) a f t e r O c t o b e r1 9 8 2 s o t h e v a r i a b l e d o e s n o t a p p e a r i n T a b l e 2 . 9

T h e s t o c k p r i c e r e s p o n s e s t o f r e e ( e x c e s s m i n u s b o r r o w e d ) r e s e r v e s a n n o u n c e m e n t sr e p r e s e n t e n t i r e l y n e w i n f o r m a t i o n f o r b o t h s u b p e r i o d s . T h e r e s p o n s e s a r e v e r y s t r o n g d u r i n gt h e f i rs t s u b p e r i o d w i t h t s t at i st i c s t h a t a r e m u c h l a r g e r t h a n t h o s e o f M 1 . A n u n a n t i c i p a t e di n c r e a s e in f r ee r e s e r v e s b y 1 % ( o f n o n - b o r r o w e d re s e r v e s , w h i c h is a p p r o x i m a t e l y 4 0 0m i l l i o n ) , in c r e a s e s th e s t o c k p ri c e i n d e x e s f ro m 0 . 1 8 % t o 0 . 2 8 % , a n d d e c r e a s e s t h e t h re e -m o n t h T r e a s u r y b i l l b y 1 2 b a s i s p o in t s . D u r i n g t h e s e c o n d s u b p e r i o d t h e r e a c t io n s t o f r eer e s e r v e s a r e n o t s i g n i fi c a n t l y d i f fe r e n t f r o m z e r o . H o w e v e r , p a r a m e t e r s t a b i li ty a c r o s s t h es u b p e r i o d s i s o n l y r e j e c t e d b y t h e t h r e e - m o n t h T r e a s u r y b i l l r a t e .

T h e m a r k e t r e s p o n s e s t o f re e r e s e r v e s a n n o u n c e m e n t s a r e c o n s i s t e n t w i t h th e E x p e c t e dR e a l I n t e r e s t R a t e h y p o t h e s i s . T o s e e th i s w e h a v e t o e x p l o r e t h e i n f o r m a t i o n a l c o n t e n t o f f r e er e s e r v e s a n n o u n c e m e n t s . T h e a n n o u n c e m e n t o f f re e re s e r v e s re f e rs to f is c a l w e e k t - 1 ,w h i c h e n d s o n l y t w o d a y s p r i o r to t h e a n n o u n c e m e n t o f w e e k t , w h i l e th e s i m u l t a n e o u sa n n o u n c e m e n t o f M 1 r e f er s to th e f is c a l w e e k t - 2 , w h i c h e n d s n i n e d a y s p r i o r to th ea n n o u n c e m e n t o f w e e k t . T h u s , t h e a n n o u n c e m e n t o f fr ee r e s e r ve s p r o v i d e s e n t ir e l y n e wi n f o r m a t i o n . F u r t h e r m o r e , p r i o r t o t h e a n n o u n c e m e n t a t w e e k t , m a r k e t s h a v e a f a ir lya c c u r a t e e s t i m a t e o f t o t a l r e s e r v e s f o r w e e k t - 1 . T h i s i s b e c a u s e u n t i l J a n u a r y 1 9 8 4 re q u i r e dr e s e r v e s o f w e e k t - 1 w e r e a f u n c t i o n o f d e m a n d d e p o s it s o f w e e k t - 3 , w h i c h w e r ea l r e a d y a n n o u n c e d a t t - 1 . A s s u m i n g th a t e x c e s s r e s e r v e s a r e p r e d i c t a b le , t h e r e is n os u r p r i s e a b o u t to t a l re s e r v e s a n d , t h u s , a p o s i ti v e s u r p ri s e a b o u t n o n - b o r r o w e d r e s e r v e s e q u a l sa n e g a t i v e s u r p r i s e a b o u t b o r r o w e d r e s e r v e s. S i m i l a r l y , w e m a y t r e a t p o s i t iv e s u r p r is e s a b o u tf r e e r e s e r v e s a s b o t h p o s i t i v e s u r p r i s e s a b o u t n o n - b o r r o w e d r e s e r v e s a n d n e g a t i v e s u r p r i s e sa b o u t b o r r o w e d r e s e r v e s . 10 I n th e O c t o b e r 1 9 7 9 - O c t o b e r 1 9 8 2 p e r i o d n o n - b o r r o w e d r e s e r v e sw e r e b o t h t h e in t r a - w e e k a n d i n t e r - w e e k i n s t r u m e n t o f m o n e t a r y c o n t r o l. M a r k e t p a r t i c i p a n t s

8 Fo r precise mod els on the interest rate response to M1 anno uncem ents see Engel and Frankel (1984),Nichols, Sm all, and Webster (1983), or Hardou velis (198 5b ). M ost authors have interpreted the marketresponses to MI announcements as evidence of the Federal Reserve's credibility. When markets perceive thatthe Federal R eserve follows a steady m oney growth path, they believe that unanticipated changes in the stock ofmon ey will be counteracted soon. Acco rding to the Expected Real Interest Rate hypothesis, the expectation o f afuture restriction in m oney supply leads to a n expected increase in the real rate of interest which is required toclear the money market.9 Hafer (19 86 ) has also e xamined independently the stock price reactions to M 1 and discount rateannounce ments du ring the post-October 1982 period and reached similar conclusions.~0 Ign orin g possible surprises about excess reserves does not have any major im plications. Fo r example, inthe interest rate reactions, a model-based surprise of non-borrowed reserves provides similar results as thesurprise about free reserves; or adding a model-based surprise about total reserves has no effect on thecoefficient estimates,


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1 38 G i k a s A . H a r d o u v e l i sw e r e , t h e r e f o r e , l i k e l y t o i n t e r p re t u n a n ti c i p a te d c h a n g e s i n n o n - b o r r o w e d r e s e r v e s a sp e r s i s t e n t c h a n g e s , w h i c h w e r e i n i t i a t e d b y t h e F e d e r a l R e s e r v e i n i ts a t t e m p t t o a l t e r it si n t e r m e d i a t e ta r g e t s . T h i s e x p l a i n s t h e s t ro n g n e g a t i v e r e s p o n s e o f s h o r t - t e r m i n t e r e s t r a t e sd u r i n g t h i s p e r i o d . 11 B u t a f t e r O c t o b e r 1 9 8 2 , n o n - b o r r o w e d r e s e r v e s l o s t t h e i r s i g n i f i c a n c e a sa n i n t e r - w e e k i n s tr u m e n t . M a r k e t p a r t i c i p a n ts d i d n o t a t t ac h m u c h i m p o r t a n c e t o u n a n t i c i-p a t e d c h a n g e s i n n o n - b o r r o w e d r e s e r v e s a n d , t h u s , t h e i n t e r e s t r a t e r e s p o n s e w e a k e n e d . ~2

B Nonmonetary Announcemen t sT h e s t o c k p r i c e r e s p o n s e s t o n o n m o n e t a r y a n n o u n c e m e n t s a r e v e r y w e a k . F o r n o n e o f t hes t o c k p r i c e i n d e x e s a n d d u r i n g n e i t h e r s u b p e r i o d c a n w e r e j e c t t h e n u l l h y p o t h e s i s t h a t a ll 1 1c o e f f ic i e n t s a r e j o i n t l y d i f f er e n t f ro m z e r o ( H 3 ) . H o w e v e r , t h r e e o f t h e 11 m a c r o e c o n o m i cv a r i a b l e s ( t r a d e d e f i c i t , u n e m p l o y m e n t r a t e , p e r s o n a l i n c o m e ) d o s h o w s t a t is t i c a l ly s i g n i f i c a n tr e s p o n s e s .F r o m O c t o b e r 1 9 79 t o O c t o b e r 1 9 82 , a n u n a n t i c i p a te d i n c r e a se in t he U . S . t r a d e d e f ic i t b yo n e b i l l i o n d o l l a r s in c r e a s e d th e s t o c k p r ic e i n d e x e s b y 0 . 2 2 % t o 0 .3 2 % a n d d e c r e a s e d t h et h r e e - m o n t h T r e a s u r y b i l l r a t e b y 9 b a s i s p o i n t s . A n i n c r e a s e i n th e t r a d e d e f i c i t c a n n o t b ei n t e r p r e t e d a s g o o d n e w s a b o u t f u t u r e c a s h f l o w s , t h u s t h e i n c r e a s e in s t o c k p r i c e s i s m o s tl i k e l y t h e r e s u l t o f t h e d e c r e a s e i n s h o r t - t e r m i n t e r e s t r a t e s a l o n e .

T h e r e a c t io n s t o t he u n e m p l o y m e n t r a te b e c o m e s i g n i f i ca n t o n l y i n t h e s e c o n d s u b p e r i o d .T a b l e 2 s h o w s t h a t a n u n a n t i c ip a t e d in c r e a s e in t h e u n e m p l o y m e n t r a t e b y 1 % i n c r e a se s s t o c kp r i c e s b y 1 . 7 5 % t o 2 . 3 5 % ; i t a l s o d e c r e a s e s th e t h r e e - m o n t h T r e a s u r y b i l l r a t e b y 2 1 b a s i sp o i n t s , a n d t h e 2 0 - y e a r T r e a s u r y b o n d r a t e b y 1 9 b a s i s p o i n ts . I n t h e f ir s t s u b p e r i o d o n l y t h es h o r t - t e r m i n t e r e s t r a te s h o w s a n e g a t i v e a n d s i g n i f ic a n t r e s p o n s e . A p l a u s i b l e h y p o t h e s i sa s s o c i a t e d w i t h t h e F e d e r a l R e s e r v e ' s a b a n d o n m e n t o f s tr ic t M 1 t a r g e ts i s t h e f o l l o w i n g : a ni n c r e a s e in t h e u n e m p l o y m e n t r a t e p r o v i d e s a s ig n a l o f w e a k e n i n g a g g r e g a t e d e m a n d ( r e la t i v et o a g g r e g a t e s u p p l y ) . I n t h e a b s e n c e o f t h e F e d e r a l R e s e r v e ' s i n t er v e n ti o n , a s i n t h e O c t o b e r1 9 7 9 - O c t o b e r 1 9 8 2 p e r i o d , t h i s r e s u l t s i n a d e c r e a s e i n o u t p u t a n d i n t e r e s t r a t e s. T h e d e c r e a s ei n i n t e r e s t r a t e s t e n d s t o i n c r e a s e s t o c k p r i c e s , b u t t h e o v e r a l l e f f e c t o n s t o c k p r i c e s i sa m b i g u o u s b e c a u s e c a s h f l o w s a r e e x p e c t e d to d e c r e a se . B u t a f t e r O c t o b e r 1 9 82 , m a r k e t se x p e c t e d t h e F e d e r a l R e s e r v e t o i n t e r v e n e a n d c o u n t e r a c t t h e i n c r e a s e i n t h e u n e m p l o y m e n tr a te b y e x p a n d i n g t h e m o n e y s u p p l y u n c o n s t r a i n e d b y M 1 t a rg e t s . T h u s , s t o c k p r i c e s i n c r e a s eb e c a u s e r e a l i n t e r e s t r a t e s a r e e x p e c t e d t o d e c r e a s e a n d c a s h f l o w s a r e n o l o n g e r e x p e c t e d t od e c r e a s e a s i n t h e p r e - O c t o b e r 1 9 8 2 t i m e p e r i o d .

F r o m O c t o b e r 1 9 79 t o O c t o b e r 1 9 82 , a n u n a n t ic i p a te d in c r e a s e in p e r s o n a l in c o m e b y 1 %i n c r e a s e s t h e s t o c k p r ic e i n d e x e s b y 0 . 5 2 % t o 0 . 7 8 % ; i t a l s o d e c r e a s e s th e t h r e e - m o n t hT r e a s u r y b i l l r a t e b y 2 3 b a s i s p o i n ts a n d th e 2 0 - y e a r T r e a s u r y b o n d r a t e b y 1 8 b a s i s p o i n ts .

For a precise model, see Hardo uvelis (1987). To get the o bserved negative response it is n ecessary t h tunanticipated changes in bo rrowed reserves are perceived o be less persistent han unanticipated changes in non-borrowed reserves.~2 The slightly negative (or the absence of a positive) response of long-term interest rates is evidence against theExpected Inflation hypothesis as an explanation o reserve announcement responses. App arently, ma rkets did notperceive hat the FederalReservewas intending o alter the growth rateof M 1. Had this been the case, we should haveobserved a positive esponse of long-term nterest rates as the inflationpremium w ould adjust (and the liquidityeffectdisappear n the long run). Also notice that unlike the case o f M1 announcements, we cannot derive any conclusionsabout the Federal Reserve 's credibility. Chan ging the intermediate targets in a specific direction can be eitherconsistent or inconsistentwith the Federal Reserve's credibilitydependingon the relativepositionof M1 with respectto its pre-announcedgrowth path.


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M acroeconomic In format ion 39Give n the a lgebra i c s ign o f the r e spon ses , i t appear s t ha t unan ti c ipa t ed changes i n pe r so na lincome prov ided a s igna l o f a more pe r s i s t en t change in aggrega t e supp ly t han aggrega t edem and . Thus , an i nc rease in pe r sona l i ncome w as as soc ia t ed with an expans ion in ou tpu t anda decrease in interes t ra tes . Both o f these cause s tock pr ices to increase . Th e react ions be co m eweaker a f t e r Oc tober 1982 because t he Federa l Rese rve began fo l l owing counte rcyc l i ca lpo l i cy , r eac t ing t o fu tu re expans ions i n ou tpu t by r es tr ic t ing t he m one y supply , w hich opp osesthe decrease in interes t ra tes and the increase in s tock pr ices .

I V C o n c l u s io n sStock pr i ces r e spond pr imar i l y t o mone ta ry news . The s t ronges t r eac t i ons were obse rvedf rom October 1979 to Oc tober 1982 , a pe r iod when the Federa l Rese rve fo l l owed s t r i c tannua l M 1 t a rge t s and adopted non-bor rowed r ese rves a s bo th t he i n t r a - and in t e r -weektargets . Dur ing that per iod, unant ic ipated changes in f ree reserves had the s t rongest impactamong the mone ta ry va r i ab l es because t hey were as soc i a t ed wi th consc ious and pe r s i s t en tchanges i n non-b or row ed r ese rves . A l so , am ong a l l st ock p r i ce i ndexes , t he NY SE F inanc ia li ndex show s the s t ronges t reac t ions t o mo ne ta ry news , apparen t ly becau se t he cash f l ows off inanc i a l compan ies a r e d i r ec t ly a f f ec t ed by mo ne ta ry deve lopmen t s .

Cons i s ten t wi th t he ev idence o f Huiz inga and M ishk in (1986) , t he th ree -mon th T reasu rybill rate react ions show ed a stat istical ly significant c han ge afte r O cto be r 1982. H ow ev er,ne i the r t he r eac t i ons o f t he 20-y ea r T reasu ry bond r a te no r t he r eac ti ons o f t he four s tock pr iceindexes showed a s t ructura l break a t that t ime.

Among the nonmone ta ry news , s t ock pr i ces r e sponded to t he announcement s o f t he t r adedef ic i t, t he unem ploym ent r a te , and pe r sona l i ncome. T he r esponse t o t he unem ploym ent r a tei s s igni f icant ly s t ronger in the post -October 1982 per iod and provides some evidence thatdur ing th i s pe r iod , marke t s were expec t ing t he Federa l Rese rve t o fo l l ow a more ac t i v i s tcountercycl ica l pol icy.F ina l ly , a l t hough the re i s no overwhe lming ev idence aga ins t t he Expec t ed In f l a t i on

hypothes is , the s tock pr ice react ions are consis tent ly consis tent wi th the Expected RealInteres t Rate hypothes is .

R e f e r e n c e sBatten, Dallas S., and Tho rnton, Daniel L. Dec. 19 84 . Discount rate changes and the foreignexchange market. J o u r n a l o f ln t e r n a t i o n a l M o n e y a n d F i n a n c e 3 : 279-302.Berkman, Neil G. M ay/June 197 8. On the significance of weekly changes in M1. E c o n o m i cR e v i e w Federal Reserve Bank of Boston, pp. 5-22.Cornell, Bradford. Sept. 19 83 . The money supply announcements puzzle: Review and interpreta-tion. A m e r i c a n E c o n o m i c R e v i e w 73(4): 644-657.Engel, Ch arles, and Jeffrey Frankel. Jan. 1984. Why interest rates react to m one y announcem ents:An explanation from the foreign exchange market, J o u r n a l o f M o n e t a r y E c o n o m i c s 1 3 : 3 1 -39.Feldstein, Martin. Dec. 198 0. Inflation and the stock market. A m e r i c a n E c o n o m i c R e v i e w 70:837-847.Hafer, R . W. March 1986. The response of stock prices to changes in weekly money and the discountrate. R e v i e w Federal Reserve Ba nk of St. Lo uis, 68(3): 5-14.Hardouvelis, Gikas A. Feb. 1985a. Economic new s, exchange rates, and interest rates, First BostonW orking Paper Se ries 86-12, Colum bia University Graduate School of Business. Forthcoming,J o u r n a l o f I n t er n a t io n a l M o n e y a n d F i n a n ce .


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14 Gikas A. HardouvelisHardouvelis, Gikas A. Dec. 1985b. Exchange rates, interest rates and money stock announce-ments: A theoretical exposition. Journal of International Money and Finance 4(4):443-454.Hardouvelis, Gikas A. June 1987. Reserves announcements and interest rates: Does monetary policymatter? Forthcoming, Journal of Finance 42(2).Huizinga, John, and Mishkin, Frederic. Spring 1986. Monetary policy regime shifts and the unusualbehavior of real interest rates. Carnegie-Rochester Series on Public Policy 24:231-274.Lynge, Morgan J. Jr. (Fall) 1981. Money supply announcements and stock prices. The Journal o fPortfolio Management 8: 40-43.Nichols, Donald, Small, David, and Webster, Charles. June 1983. Why interest rates rise when anunexpected large money stock is announced. American Economic Review 73: 383-388.Palmon, Dan, and Yaari, Uzi. 1981. Share values, inflation, and escalating tax rates. Journal ofBanking and Finance 5: 395-403.Pearce, Douglas K., and Roley, V. Vance. Sept. 1983. The reaction of stock prices tounanticipated changes in money: A note. Journal o f Finance 38: 1323-1333.Pearce, Douglas K., and Roley, V. Vance. Jan. 1985. Stock prices and economic news, Journal ofBusiness 58: 49-68.Roley, V. Vance, and Troll, Rick. Jan. 1984. The impact of discount rate changes on market interestrates. Economic Review Federal Reserve Bank of Kansas City, pp. 27-39.Smirlock, Michael and Jess Yawitz. Sept. 1985. Asset returns, discount rate changes, and marketefficiency. Journal of Finance 40(4): 1141-1158.Theil, Henri. 1971. Principles o f Econometrics. New York: John Wiley Sons, Inc.

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