The effects of deviations from Taylor rule-based policy on the U.S. stock market

I analyze the effects on the S&P500 stock price index returns from deviations between the Federal funds rate and the rate derived from the Taylor Rule to examine if the Fed should have followed Taylor’s prescriptions. A dynamic linear model allows to find that there is no statistical evidence that a relation exists between S&P500 stock returns and deviations of the federal funds rate from the rate prescribed by modified Taylor rules. The modifications include a change of the measure of inflation, namely the use of the Personal Consumption Expenditure quarter growth rate instead of the GDP deflator, and alternative values for the responsiveness to the output gap and the equilibrium federal funds rate. Based on this paper, there is no evidence showing that the Fed’s monetary policy choices could have had a positive impact on the stock market should they have followed Taylor’s prescriptions.