Excess elasticity in the financial system? A study of how macroeconomic variables affect stock prices
Abstract: Asset prices have had larger and more rapid increases since 1980 when compared to the post-war period, especially compared to the Bretton Woods period. In this thesis we test whether the excess elasticity view provides a plausible explanation for this change. The excess elasticity view, put forth by Borio and Disyatat (2011) and Borio and White (2003), argues that the financial system has become more elastic because regulations on the financial system have been relaxed and the creation of credit has become less constrained. We test the theory by analyzing whether the effect of macroeconomic variables on stock prices have increased after the financial system became more liberalized, which we identify to have occurred after the Bretton Woods system was abandoned 1971 and then post 1980 when the financial liberalization process accelerated. Three hypotheses connected to the excess elasticity view are tested in a series of regressions, using a quarterly panel containing 16 OECD countries and eight macroeconomic variables, during the time period 1960-2017. Our results show that there exist breakpoints in the effect of macroeconomic variables during the sample period, implicating that some fundamental aspects of the economy have changed. However, they do not indicate support for the excess elasticity view; rather the regulated financial environment of the Bretton Woods period seems to have amplified the effect of macroeconomic variables on stock prices.
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