The Impact of Monetary Policy on Iraq Stock Exchange

Abstract : Previous research indicates that the stock market plays an important role in transmitting monetary policy shocks to the real economy. Building on this premise, this study explores the relationship between the nominal and real returns of the Iraq Stock Exchange (ISX) general index and monetary policy in Iraq by employing a specialised structural identification method – the sign-restriction approach. Monetary policy shocks are identified by imposing theoretically consistent sign restrictions on the impulse response functions. The analysis focuses on the effects of monetary policy shocks on nominal and real stock returns across three distinct monetary regimes: (i) the restrictive (contractionary) monetary policy periods (2004–2007 and 2011–2012), (ii) the accommodative (expansionary) monetary policy periods (2008–2010 and 2013–2016), and (iii) the output-targeting monetary policy period (2017–2024). Quantitatively, the study shows that during the restrictive monetary regime a contractionary policy shock causes a sizeable decline of about 0.43 percent in the nominal return of the ISX general index, while the response of the real return is almost nil and tends towards zero. This outcome is consistent with the iterative and empirical evidence in the literature. Surprisingly, the accommodative and output-targeting regimes generate a weak but noticeable positive response (0.04) in the nominal return and a negative response in the real return of the market index. The results suggest that the narrowness of the Iraqi stock market, its weak integration with the domestic economy, and the structural characteristics of the financial system all tend to dampen the transmission of monetary policy to stock returns.