Monetary policy and bubbles in G7 economies using a panel VAR approach: Implications for sustainable development

Abstract

We use the LPPLS Multi-Scale Confidence Indicator approach to detect both positive and negative bubbles in the short-, medium- and long-run for the stock markets of the G7 countries. We were able to detect major crashes and rallies in the seven stock markets over the monthly period of 1973:02 to 2020:09. We also observed similar timing of strong (positive and negative) LPPLS indicator values across the G7 countries, suggesting synchronized extreme movements in these stock markets. Given this, to obtain an overall picture of the G7, we used a panel VAR model to analyze the impact of monetary policy shocks on the six indicators of bubbles. We found that monetary policy not only impacts the bubble indicators but also responds to them, with the nature of the underlying responses contingent on whether bubbles are positive or negative in nature, as well as the time-scale we are analyzing. In light of these findings, our results have serious implications for monetary authorities of these advanced markets in terms of sustainable development, given the finance-growth nexus. But in general, we can conclude that central banks of the G7 can indeed “lean against the wind”, and they have also been doing so under both conventional and unconventional monetary policy periods.

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