Monetary Policy, Stock Returns, and the Role of Credit in the Transmission of Monetary Policy

What causes business cycle fluctuations? Do they arise from real factors such as productivity shocks and taste changes, or do nominal factors such as changes in monetary policy also matter? If monetary factors affect real variables, what are the channels transmitting policy changes to the economy? This paper addresses these questions by examining the response of stock returns to monetary policy shocks and other macroeconomic variables. It finds that these common factors explain a substantial portion of the variation in stock returns, indicating that economic fluctuations are not due to real factors alone. It also finds that disinflationary monetary policy harms both small and large firms while expansionary policy benefits large but not small firms. 

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