The federal funds rate and the arbitrage pricing theory: Evidence that monetary policy matters

Macroeconomists disagree concerning whether monetary policy affects real variables. Recently, Bernanke and Blinder have presented evidence that the federal funds rate is a good indicator of monetary policy and that it forecasts real variables well. Here we use a nonlinear seemingly unrelated regression technique to demonstrate that the funds rate is a priced factor in the arbitrage pricing model and that unexpected increases (decreases) in the funds rate lower (raise) stock prices. This provides evidence from a different data set using a different methodology corroborating Bernanke and Blinder's finding that monetary policy working through the funds rate affects real activity.