The interaction between money and asset markets: A spillover index approach

• Interaction between money and financial assets rises in periods of turbulence.
• Financial assets’ spillover with M2 tends to be greater than with the monetary base.
• Relatively high interaction between M2 and stocks is notable.
• That between monetary base and government bonds less than expected in recent years.
• During Lehman post-bankruptcy period, M2 has stronger influence on the monetary base.

We employ Diebold and Yilmaz, 2009 and Diebold and Yilmaz, 2012 spillover approach to study the relationship between US money and financial assets since 2000. We find that sizeable spillovers arise during periods of economic and financial turbulence (after the 11 September 2001 terrorist attacks, the post-Lehman Brothers bankruptcy period, and in the second half of 2011 when there were concerns about sovereign market developments). Households readjusting their portfolios between holdings of risky financial assets and nominal-certain money may have been the dominant factor at play in explaining this. The interaction of the monetary base with the financial assets in recent years is less than that of M2 with them, a perhaps surprising feature given the balance sheet policies pursued by the Federal Reserve during this time.