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Sadeghi S, behbudi D, hosseyni S M. The impact of monetary policy on the stock price bubble in selected countries of the D8 group. QJER 2024;
URL: http://ecor.modares.ac.ir/article-18-76085-en.html
URL: http://ecor.modares.ac.ir/article-18-76085-en.html
1- Professor, Department of Economic Development and Planning, Faculty of Economics and Management, Tabriz University, Tabriz, Iran , sadeghiseyedkamal@gmail.com
2- Professor, Department of Economic Development and Planning, Faculty of Economics and Management, Tabriz University, Tabriz, Iran
3- Master's Student in Economics, Faculty of Economics and Management, Tabriz University, Tabriz, Iran
2- Professor, Department of Economic Development and Planning, Faculty of Economics and Management, Tabriz University, Tabriz, Iran
3- Master's Student in Economics, Faculty of Economics and Management, Tabriz University, Tabriz, Iran
Abstract: (127 Views)
Aim and Introduction
Asset bubbles arise when the prices of assets – such as real estate or stocks –significantly exceed their intrinsic value due to excessive speculation and investor euphoria. These bubbles are typically characterized by rapid price escalations that become disconnected from fundamental economic indicators, driven more by market psychology than by real economic value. Although asset bubbles may generate short-term economic benefits, they pose serious risks to financial stability, as their eventual collapse often results in sharp market corrections, financial crises, and broader economic downturns.
Monetary policy, primarily executed by central banks, plays a critical role in influencing macroeconomic conditions through liquidity management, credit accessibility, and interest rate adjustments. On the one hand, expansionary monetary policies—characterized by low interest rates and increased liquidity—can stimulate speculative investment and contribute to the formation of asset bubbles. On the other hand, central banks can use contractionary policies—such as raising interest rates or reducing liquidity—to dampen excessive market exuberance and promote financial stability.
The complex relationship between asset bubbles and monetary policy underscores a significant challenge for economists and policymakers, who must balance the goals of economic growth and financial stability. A nuanced understanding of this relationship is crucial for designing effective regulatory frameworks and policy interventions capable of mitigating harmful boom-and-bust cycles and fostering sustainable economic development.
Methodology
This study examines stock market bubbles and the influence of monetary policy in five D-8 countries, Iran, Turkey, Indonesia, Malaysia, and Egypt, over the period 2009–2023. Two key analytical approaches are employed:
Log-Periodic Power Law Singularity with Confidence Interval (LPPLS-CI) for detecting stock price bubbles, and
Asset bubbles arise when the prices of assets – such as real estate or stocks –significantly exceed their intrinsic value due to excessive speculation and investor euphoria. These bubbles are typically characterized by rapid price escalations that become disconnected from fundamental economic indicators, driven more by market psychology than by real economic value. Although asset bubbles may generate short-term economic benefits, they pose serious risks to financial stability, as their eventual collapse often results in sharp market corrections, financial crises, and broader economic downturns.
Monetary policy, primarily executed by central banks, plays a critical role in influencing macroeconomic conditions through liquidity management, credit accessibility, and interest rate adjustments. On the one hand, expansionary monetary policies—characterized by low interest rates and increased liquidity—can stimulate speculative investment and contribute to the formation of asset bubbles. On the other hand, central banks can use contractionary policies—such as raising interest rates or reducing liquidity—to dampen excessive market exuberance and promote financial stability.
The complex relationship between asset bubbles and monetary policy underscores a significant challenge for economists and policymakers, who must balance the goals of economic growth and financial stability. A nuanced understanding of this relationship is crucial for designing effective regulatory frameworks and policy interventions capable of mitigating harmful boom-and-bust cycles and fostering sustainable economic development.
Methodology
This study examines stock market bubbles and the influence of monetary policy in five D-8 countries, Iran, Turkey, Indonesia, Malaysia, and Egypt, over the period 2009–2023. Two key analytical approaches are employed:
Log-Periodic Power Law Singularity with Confidence Interval (LPPLS-CI) for detecting stock price bubbles, and
- Panel Vector Autoregression (P-VAR) for assessing the dynamic impact of monetary policy variables.
The LPPLS-CI model enhances traditional LPPLS techniques by incorporating confidence intervals, thus improving the accuracy and robustness of bubble detection. This model identifies unsustainable asset price growth and log-periodic oscillations—signals typically preceding bubble collapses. Its predictive capacity offers early warning signals that are valuable for financial market monitoring.
To evaluate the effects of monetary policy on these bubbles, the study employs the P-VAR model. This econometric framework captures interdependencies between multiple time-series variables—including stock prices, interest rates, inflation, and liquidity—by analyzing their lagged interactions. This comprehensive approach facilitates a dynamic understanding of how monetary policy decisions shape speculative trends and bubble formation. The effectiveness of this analysis depends on key methodological considerations, including appropriate model specification, lag length selection, and rigorous validation techniques.
Results and Discussion
The LPPLS-CI analysis confirms the presence of stock price bubbles across various time scales (short-, medium-, and long-term) in the selected countries throughout the 2009–2023 period. These bubbles were characterized by rapid price increases fueled by speculative behavior and optimistic market sentiment, ultimately followed by sharp corrections.
The P-VAR results demonstrated that high inflation, increased liquidity, and low interest rates were key contributors to bubble formation. These conditions encouraged capital inflows into financial markets, driving up stock prices beyond sustainable levels. However, as monetary policy conditions tightened or external economic shocks emerged, these bubbles burst, resulting in significant financial losses and increased market volatility.
The findings underscore the dual nature of monetary policy: while accommodative policies can promote growth and investment, they also risk inflating asset bubbles. The study emphasizes the need for balanced and proactive policy responses to prevent systemic instability. Regulatory oversight, timely monetary adjustments, and enhanced early warning mechanisms are crucial in minimizing the risks associated with speculative excesses.
Conclusion
Monetary policy in the examined D-8 countries significantly influences the formation and trajectory of stock market bubbles. Expansionary policies may exacerbate bubbles, leading to financial shocks, economic contractions, and capital flight when the bubbles burst. The study underscores the imperative for central banks in emerging markets to carefully manage accurate interest rates, control inflation, and stabilize liquidity to safeguard financial markets.
Key components of monetary policy affecting asset bubbles include:
To evaluate the effects of monetary policy on these bubbles, the study employs the P-VAR model. This econometric framework captures interdependencies between multiple time-series variables—including stock prices, interest rates, inflation, and liquidity—by analyzing their lagged interactions. This comprehensive approach facilitates a dynamic understanding of how monetary policy decisions shape speculative trends and bubble formation. The effectiveness of this analysis depends on key methodological considerations, including appropriate model specification, lag length selection, and rigorous validation techniques.
Results and Discussion
The LPPLS-CI analysis confirms the presence of stock price bubbles across various time scales (short-, medium-, and long-term) in the selected countries throughout the 2009–2023 period. These bubbles were characterized by rapid price increases fueled by speculative behavior and optimistic market sentiment, ultimately followed by sharp corrections.
The P-VAR results demonstrated that high inflation, increased liquidity, and low interest rates were key contributors to bubble formation. These conditions encouraged capital inflows into financial markets, driving up stock prices beyond sustainable levels. However, as monetary policy conditions tightened or external economic shocks emerged, these bubbles burst, resulting in significant financial losses and increased market volatility.
The findings underscore the dual nature of monetary policy: while accommodative policies can promote growth and investment, they also risk inflating asset bubbles. The study emphasizes the need for balanced and proactive policy responses to prevent systemic instability. Regulatory oversight, timely monetary adjustments, and enhanced early warning mechanisms are crucial in minimizing the risks associated with speculative excesses.
Conclusion
Monetary policy in the examined D-8 countries significantly influences the formation and trajectory of stock market bubbles. Expansionary policies may exacerbate bubbles, leading to financial shocks, economic contractions, and capital flight when the bubbles burst. The study underscores the imperative for central banks in emerging markets to carefully manage accurate interest rates, control inflation, and stabilize liquidity to safeguard financial markets.
Key components of monetary policy affecting asset bubbles include:
- Interest Rates: Low rates can stimulate borrowing and speculation, while higher rates can curb overheating but may suppress growth.
- Quantitative Easing (QE): Although QE enhances liquidity and asset values, prolonged implementation can fuel speculative bubbles.
To prevent crises, Policy recommendations include:
- Regulatory Oversight: Strengthen financial regulations to enhance transparency and mitigate systemic risks.
- Macroprudential Tools: Implement counter-cyclical capital buffers and risk-weighted asset requirements.
- Monetary Policy Adjustments: Implement forward guidance and timely rate changes to manage expectations.
- Early Warning Systems: Monitor key financial indicators to detect signs of market overheating.
- Investment Diversification: Encourage asset diversification to reduce systemic exposure.
Implementing these strategies can help minimize the occurrence and adverse consequences of asset bubbles, contributing to more resilient financial systems and sustainable economic growth in the D-8 member countries.
Article Type: Original Research |
Subject:
Economics, Econometrics and Finance (General)
Received: 2024/07/14 | Accepted: 2024/08/10
Received: 2024/07/14 | Accepted: 2024/08/10
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