International evidence on equity prices, interest rates and money

In this article, I estimate the dynamic response of output and asset prices - bond yields and real equity price indices - to money supply shocks in eight industrialized economies over the post-war period. To identify money supply shocks, I assume only that such shocks are neutral in the long-run. The reliability of this identification procedure is examined in light of the recent critique by Faust and Leeper. The findings indicate that a real liquidity effect exists in both bond and stock markets, for most of the countries in the sample, although there is substantial variation in the magnitudes of the effects across countries. The response of real equity prices to money supply innovations has not been well-documented in the literature, and has typically been ignored in the debate over the monetary transmission mechanism. The importance of these findings lies in suggesting ways to improve our understanding of the monetary transmission mechanism and the role of asset markets. (C) 1998 Elsevier Science Ltd. All rights reserved.