RDP 2021-04: Monetary Policy, Equity Markets and the Information Effect 10. Conclusion

The effects of monetary policy remains a core question at the heart of macroeconomics. Despite standard macroeconomic models predicting a monetary easing as having an expansionary effect, recent work has challenged this notion by identifying so-called ‘information effects’, where a monetary easing could have a contractionary effect.

This paper explores whether the information effect exists in Australian equity markets. Using high-frequency financial market and weekly forecasts for identification, I document the effect of monetary policy on Australian equity prices and equity earnings forecasts. The results suggest that, to the extent that it exists, the information effect of monetary policy does not play a large role in the response of equity markets following monetary policy announcements. Rather, monetary policy announcements in Australia have the standard effects on equity markets. I show that monetary tightening leads to declines in equity prices. Furthermore, I show that this decline in equity prices is at least in part driven by declines in equity earnings forecasts. But when considering other forms of central bank communication I provide some evidence that an information effect may be present. Consistent with the information effect, monetary tightening caused by speeches delivered by the RBA Governor are followed by increases in equity prices and upward revisions in forecasted earnings.

Taken together, the results suggests that the information effect of monetary policy is, at least in equity markets, unlikely to have been an important channel in the transmission of Australian monetary policy. But the information effect could be present under certain conditions and when using specific communication tools.