Author(s):	Harald Hau, Sandy Lai
Publication Date:	August 2013
Keyword(s):	asset price inflation, monetary policy, risk seeking, Taylor rule residuals
JEL(s):	G11, G14, G23
Programme Areas:	International Macroeconomics, Financial Economics
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=9581

The eurozone has a single short-term nominal interest rate, but monetary policy conditions measured by either real short-term interest rates or Taylor rule residuals varied substantially across countries in the period from 2003-2010. We use this cross-country variation in the (local) tightness of monetary policy to examine its influence on equity and money market flows. In line with a powerful risk-shifting channel, we find that fund investors in countries with decreased real interest rates shift their portfolio investment out of the money market and into the riskier equity market. A ten-basis-point lower real short-term interest rate is associated with a 0.8% incremental money market outflow and a 1% incremental equity market inflow by local investors relative to asset under management. The latter produces the strongest equity price increase in countries where domestic institutional investors represent a large share of the countries' stock market capitalization.