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Asset prices, financial conditions and the transmission of monetary policy

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  • Charles Goodhart
  • Boris Hofmann

Abstract

In this paper we assess the role of asset prices as information variables for aggregate demand conditions and in the transmission of monetary policy. A Monetary Conditions Index, a weighted average of the short-term interest rate and the exchange rate, has commonly been used as a composite measure of the stance of monetary policy and aggregate demand conditions. However, other asset prices, property and share prices, also affect aggregate demand. By looking at reduced form coefficient estimates and VAR impulse responses we derive Financial Conditions Indices, a weighted average of the short-term real interest rate, the effective real exchange rate, real property and real share prices, for the G7 countries. We find that house and share prices get a substantial weight in such an index and that the derived Financial Conditions Indices contain useful information about future inflationary pressures.

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Bibliographic Info

Article provided by Federal Reserve Bank of San Francisco in its journal Proceedings.

Volume (Year): (2001)
Issue (Month): Mar ()
Pages:

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Handle: RePEc:fip:fedfpr:y:2001:i:mar:x:3

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Keywords: Monetary policy ; Asset pricing ; Inflation (Finance);

References

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  1. Rudebusch, Glenn D & Svensson, Lars E O, 1998. "Policy Rules for Inflation Targeting," CEPR Discussion Papers 1999, C.E.P.R. Discussion Papers.
  2. Stephen G. Cecchetti, 1995. "Inflation Indicators and Inflation Policy," NBER Working Papers 5161, National Bureau of Economic Research, Inc.
  3. James G. MacKinnon, 1990. "Critical Values for Cointegration Tests," Working Papers 1227, Queen's University, Department of Economics.
  4. Bernanke, Ben S. & Gertler, Mark & Gilchrist, Simon, 1999. "The financial accelerator in a quantitative business cycle framework," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 21, pages 1341-1393 Elsevier.
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Citations

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Cited by:
  1. Hilde C. Bjørnland & Dag Henning Jacobsen, 2009. "The role of house prices in the monetary policy transmission mechanism in small open economies," Working Paper 2009/06, Norges Bank.
  2. Castro, Vítor, 2008. "Are Central Banks following a linear or nonlinear (augmented) Taylor rule?," The Warwick Economics Research Paper Series (TWERPS) 872, University of Warwick, Department of Economics.
  3. Jan Willem van den End, 2006. "Indicator and boundaries of financial stability," DNB Working Papers 097, Netherlands Central Bank, Research Department.
  4. Angelopoulou, Eleni & Balfoussia, Hiona & Gibson, Heather D., 2014. "Building a financial conditions index for the euro area and selected euro area countries: What does it tell us about the crisis?," Economic Modelling, Elsevier, vol. 38(C), pages 392-403.
  5. Alexandros Kontonikas & Christos Ioannidis, 2003. "Should Monetary Policy Respond to Asset Price Misalignments?," Economics and Finance Discussion Papers 03-19, Economics and Finance Section, School of Social Sciences, Brunel University.
  6. Patrick Artus, 2003. "Pourquoi la politique monétaire ne réagit-elle pas aux prix d’actifs ?," Économie et Prévision, Programme National Persée, vol. 158(2), pages 61-71.
  7. Gongpil Choi, 2003. "The Choice of Monetary Regime for Post-Crisis Asia. The Case of South Korea," Revue économique, Presses de Sciences-Po, vol. 54(5), pages 1137-1160.
  8. Akhter Faroque & William Veloce & Jean-Francois Lamarche, 2008. "The impact of structural breaks on the stability of the out-of-sample predictive content of financial variables for Canada's real GDP growth: An encompassing approach," Working Papers 0803, Brock University, Department of Economics.
  9. Siklos, Pierre L. & Bohl, Martin T. & Werner, Thomas, 2003. "Did the Bundesbank React to Stock Price Movements?," Discussion Paper Series 1: Economic Studies 2003,14, Deutsche Bundesbank, Research Centre.
  10. Kimberly Beaton & René Lalonde & Corinne Luu, 2009. "A Financial Conditions Index for the United States," Discussion Papers 09-11, Bank of Canada.
  11. Wong Keung-Wing & Habibullah Khan & Jun Du, 2006. "Money, Interest Rate and Stock Prices: New Evidence from Singapore and The United States," Departmental Working Papers wp0601, National University of Singapore, Department of Economics.
  12. Vítor, Castro, 2011. "Can central banks' monetary policy be described by a linear (augmented) Taylor rule or by a nonlinear rule?," Journal of Financial Stability, Elsevier, vol. 7(4), pages 228-246, December.

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