Abstract:

This paper, by using VAR methodology, presents evidence that the monetary policy of a large country causally affects not only that country’s stock prices but also asset prices abroad. Besides this it also tests the theoretical implications of the four major international macroeconomic theories and compares the test results with these predictions. In theory expansionary monetary shocks of a large country will reduce domestic and world interest rates, depreciate the domestic currency, and increases domestic output. Increases in the domestic output will raise the demand for foreign goods. The depreciation of the domestic currency, in turn, will decrease foreign price levels and increases foreign real balances, since the depreciation of the currency reduces the foreign currency price of imports. The fall in the foreign country interest rates and the aggregate demand spillover from the large economy will stimulate foreign output, consumption and investment. Thus, expansionary monetary policy in the large economy should not only increase output and, thereby, asset returns domestically, but also abroad

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