percentage point and 1 - 1 / 2 percentage points. second, the main reason that unanticipated changes in monetary policy affect stock prices is that they affect the risk premium on stocks. in particular, a surprise tightening of policy raises the risk premium, lowering current stock prices, and a surprise easing lowers the risk premium, raising current stock prices. what implications do these results have for our broader understanding and for the practice of monetary policy? i will briefly discuss two issues : first, the role of the stock market in the transmission of monetary policy changes to the economy ; and second, the efficacy of monetary policy as a tool for controlling stock market " bubbles. " a long - held element of the conventional wisdom is that the stock market is an important part of the transmission mechanism for monetary policy. the logic goes as follows : easier monetary policy, for example, raises stock prices. higher stock prices increase the wealth of households, prompting 12 - month moving average ), the change in the bill rate, the smoothed dividend - price ratio, and the spread between 10 - year and one - month treasury yields. consumers to spend more - - a result known as the wealth effect. moreover, high stock prices effectively reduce the cost of capital for firms, stimulating increased capital investment. increases in both types of spending - - consumer spending and business spending - - tend to stimulate the economy. this simple story can be elaborated somewhat in light of our results. it is true, as i have discussed, that an easier monetary policy raises stock prices, whereas a tighter policy lowers them. however, easier monetary policy not only raises stock prices ; as we have seen, it also lowers risk premiums, presumably reflecting both a reduction in economic and financial volatility and an increase in the capacity of financial investors to bear risk. thus, our results suggest that easier monetary policy not only allows consumers to enjoy a capital gain in their stock portfolios today, but it also reduces the effective amount of economic and financial risk they must face. this reduction in risk may cause consumers to trim their precautionary saving, that is, to reduce the amount of income that they put aside to protect themselves against unforeseen contingencies. reduced precautionary saving in turn implies more spending by households. thus, the reduction in risk associated with an easing of monetary policy and the resulting reduction in precautionary saving may amplify the short - run impact of policy operating through the traditional channel based on

i asked two questions. first, by how much do changes in monetary policy affect equity prices? as you will see, we focus on changes in monetary policy that are unanticipated by market participants because anticipated changes in policy should already be discounted by stock market investors and, hence, are unlikely to affect equity prices at the time they are announced. we find an effect of moderate size : monetary policy matters for the stock market but, on the other hand, it is not one of the major influences on equity prices. our second question, both more interesting and more difficult, is, why do changes in monetary policy affect stock prices? we come up with a rather surprising answer, at least one that was surprising to us. we find that unanticipated changes in monetary policy affect stock prices not so much by influencing expected dividends or the risk - free real interest rate, but rather by affecting the perceived riskiness of stocks. a tightening of monetary policy, for example, leads investors to view stocks as riskier investments and thus to demand a higher return to hold stocks. for a given path of expected dividends, a higher expected return can be achieved only by a fall in the current stock price. as we will see, this finding has interesting implications for several issues, including the role of stock prices in transmitting the effects of monetary policy actions to the broader economy and the potential effectiveness of monetary policy in " pricking " putative bubbles in the stock market. i will come back to these issues at the end of my talk. i start, however, with the problem of measuring the effect of monetary policy on the stock market. bernanke and kuttner ( 2003 ) ; http : / / home. earthlink. net / ~ kkuttner / bernanke - kuttner. pdf the effect of monetary policy actions on the stock market normally, the fomc, the monetary policymaking arm of the federal reserve, announces its interest rate decisions at around 2 : 15 p. m. following each of its eight regularly scheduled meetings each year. an air of expectation reigns in financial markets in the few minutes before to the announcement. if you happen to have access to a monitor that tracks key market indexes, at 2 : 15 p. m. on an announcement day you can watch those indexes quiver as if trying to digest the information in the rate decision and the fomc's accompanying statement of explanation. then the black line representing