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Monetary policy rules, asset prices and adaptive learning

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  • Machado, Vicente da Gama

Abstract

Following the damaging real effects of asset price fluctuations over the recent financial crisis, the debate on the appropriate role of such prices in a monetary policy context has gained renewed attention. This paper argues that a direct monetary policy response to asset prices is not desirable under common instrumental rate rules. To illustrate this point, we build an adaptive learning model, that extends existing learning models in monetary policy, most notably, Bullard and Mitra (2002). The result remains valid in a context with heterogeneous beliefs and is robust to an optimal monetary policy rule including a weight on asset prices.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Financial Stability.

Volume (Year): 9 (2013)
Issue (Month): 3 ()
Pages: 251-258

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Handle: RePEc:eee:finsta:v:9:y:2013:i:3:p:251-258

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Web page: http://www.elsevier.com/locate/jfstabil

Related research

Keywords: Interest rate rules; Asset prices; Adaptive learning; Expectational stability;

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References

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  1. George W. Evans & Seppo Honkapohja, 2001. "Expectations and the Stability Problem for Optimal Monetary Policies," University of Oregon Economics Department Working Papers 2001-6, University of Oregon Economics Department, revised 03 Aug 2001.
  2. repec:fip:fedgsq:y:2007:i:jul10 is not listed on IDEAS
  3. Pfajfar, Damjan & Santoro, Emiliano, 2010. "Heterogeneity, learning and information stickiness in inflation expectations," Journal of Economic Behavior & Organization, Elsevier, vol. 75(3), pages 426-444, September.
  4. James Bullard & Kaushik Mitra, 2002. "Learning about monetary policy rules," Working Papers 2000-001, Federal Reserve Bank of St. Louis.
  5. Bennett T. McCallum, 1997. "Issues in the Design of Monetary Policy Rules," NBER Working Papers 6016, National Bureau of Economic Research, Inc.
  6. Charles T. Carlstrom & Timothy Fuerst, 2007. "Asset Prices, Nominal Rigidities, and Monetary Policy," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 10(2), pages 256-275, April.
  7. Ben S. Bernanke, 2007. "Inflation expectations and inflation forecasting," Speech 306, Board of Governors of the Federal Reserve System (U.S.).
  8. Kaushik Mitra & Seppo Honkapohja, 2004. "Are Non-Fundamental Equilibria Learnable in Models of Monetary Policy?," Royal Holloway, University of London: Discussion Papers in Economics 04/13, Department of Economics, Royal Holloway University of London, revised Jul 2004.
  9. James Bullard, 2010. "Three lessons for monetary policy from the panic of 2008," Review, Federal Reserve Bank of St. Louis, issue May, pages 155-163.
  10. Pfajfar, D. & Santoro, E., 2012. "Credit Market Distortions, Asset Prices and Monetary Policy," Discussion Paper 2012-010, Tilburg University, Center for Economic Research.
  11. George W. Evans & William A.Branch, 2010. "Monetary Policy and Heterogeneous Expectations," University of Oregon Economics Department Working Papers 2010-4, University of Oregon Economics Department.
  12. Ben S. Bernanke & Mark Gertler, 2001. "Should Central Banks Respond to Movements in Asset Prices?," American Economic Review, American Economic Association, vol. 91(2), pages 253-257, May.
  13. Branch, William A. & McGough, Bruce, 2009. "A New Keynesian model with heterogeneous expectations," Journal of Economic Dynamics and Control, Elsevier, vol. 33(5), pages 1036-1051, May.
  14. Ida, Daisuke, 2011. "Monetary policy and asset prices in an open economy," The North American Journal of Economics and Finance, Elsevier, vol. 22(2), pages 102-117, August.
  15. Guse, Eran A., 2005. "Stability properties for learning with heterogeneous expectations and multiple equilibria," Journal of Economic Dynamics and Control, Elsevier, vol. 29(10), pages 1623-1642, October.
  16. Evans, George W. & Honkapohja, Seppo, 2002. "Adaptive learning and monetary policy design," Research Discussion Papers 29/2002, Bank of Finland.
  17. Cars H. Hommes, 2005. "Heterogeneous Agent Models in Economics and Finance," Tinbergen Institute Discussion Papers 05-056/1, Tinbergen Institute.
  18. Rabanal, Pau, 2007. "Does inflation increase after a monetary policy tightening? Answers based on an estimated DSGE model," Journal of Economic Dynamics and Control, Elsevier, vol. 31(3), pages 906-937, March.
  19. Branch, William A., 2007. "Sticky information and model uncertainty in survey data on inflation expectations," Journal of Economic Dynamics and Control, Elsevier, vol. 31(1), pages 245-276, January.
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