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Did the ECB respond to the stock market before the crisis?

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Author Info

  • Botzen, W.J. Wouter
  • Marey, Philip S.

Abstract

The recent financial crisis has shown that the economic consequences of financial instability can be devastating. The consensus on the role that asset prices should play in monetary policy appears to be shifting. The pre-crisis consensus that monetary policy should only take asset prices into account, insofar as they affect inflation, is being challenged. In particular, it has recently been suggested that the monetary pillar of European Central Bank (ECB) policy provides an institutional framework to incorporate financial indicators, such as asset prices, in interest rate policy. This paper empirically examines the influence of stock price developments on the monetary policy of the ECB before the crisis. For this purpose, augmented forward-looking Taylor rules are estimated for the ECB using monthly data between 1999 and 2005. Of special interest is the effect of adding stock prices as arguments to the standard Taylor rule of the ECB. The GMM estimations suggest that the stock price developments already had an influence on ECB interest rates before the crisis. We offer an institutional explanation based on the monetary pillar of ECB policy and argue that this pillar has already served as a de facto conduit for stock prices to affect monetary policy before the outbreak of the financial crisis. We discuss the policy implications of our findings.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Policy Modeling.

Volume (Year): 32 (2010)
Issue (Month): 3 (May)
Pages: 303-322

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Handle: RePEc:eee:jpolmo:v:32:y::i:3:p:303-322

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Web page: http://www.elsevier.com/locate/inca/505735

Related research

Keywords: Asset prices ECB monetary policy Financial crisis Stock price bubbles Taylor rules;

References

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Citations

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Cited by:
  1. Dong Jin Lee & Jong Chil Son, 2011. "Nonlinearity and Structural Breaks in Monetary Policy Rules with Stock Prices," Working papers 2011-19, University of Connecticut, Department of Economics.
  2. Vranceanu, Radu, 2012. "The Euro sovereign debt crisis and the built-in instability of the Euro," ESSEC Working Papers WP1211, ESSEC Research Center, ESSEC Business School.
  3. Hoffmann, Andreas, 2012. "Did the Fed and ECB react asymmetrically with respect to asset market developments?," Working Papers 103, University of Leipzig, Faculty of Economics and Management Science.
  4. Daniel Komlan Fiodendji, 2012. "Should Canadian Monetary Policy Respond to Asset Prices? Evidence from a Structural Model," Working Papers 1209E, University of Ottawa, Department of Economics.
  5. Claudiu Albulescu & Daniel Goyeau & Dominique Pépin, 2013. "Financial instability and ECB monetary policy," Post-Print halshs-00943753, HAL.
  6. FIodendji, Komlan, 2011. "Should Canadian monetary policy respond to asset prices? Evidence from a structural model," MPRA Paper 28039, University Library of Munich, Germany, revised 10 Jan 2011.
  7. Ansgar Belke & Jens Klose, 2012. "Modifying Taylor Reaction Functions in Presence of the Zero-Lower-Bound – Evidence for the ECB and the Fed," ROME Working Papers 201203, ROME Network.
  8. Belke, Ansgar & Klose, Jens, 2013. "Modifying Taylor reaction functions in the presence of the zero‐lower‐bound — Evidence for the ECB and the Fed," Economic Modelling, Elsevier, vol. 35(C), pages 515-527.
  9. Paradiso, Antonio & Rao, B. Bhaskara, 2011. "The effects of Minsky moment and stock prices on the US Taylor Rule," MPRA Paper 27840, University Library of Munich, Germany.
  10. Lee, Dong Jin & Son, Jong Chil, 2013. "Nonlinearity and structural breaks in monetary policy rules with stock prices," Economic Modelling, Elsevier, vol. 31(C), pages 1-11.

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