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Monetary policy and asset prices: to respond or not?

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  • Q. Farooq Akram

    (Norges Bank, Norway)

  • Gunnar Bärdsen
  • Øyvind Eitrheim

    (Norges Bank, Norway)

Abstract

We investigate whether there is a case for asset prices in interest rates rules within a small econometric model of the Norwegian economy, modelling the interdependence of the real economy, credit and three classes of asset prices: housing prices, equity prices and the nominal exchange rate. We compare the performance of simple interest rate rules that allow for additional response to movements in asset prices to the performance of more standard monetary policy rules. We find that including housing and|or equity prices in the policy rules improve macroeconomic performance in terms of both nominal and real economic stability. In contrast, responding to exchange rate fluctuations seems less effective to this end, mainly because the instrument must be used quite actively, which contributes to higher volatility in general. Copyright © 2006 John Wiley & Sons, Ltd.

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File URL: http://hdl.handle.net/10.1002/ijfe.298
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Bibliographic Info

Article provided by John Wiley & Sons, Ltd. in its journal International Journal of Finance & Economics.

Volume (Year): 11 (2006)
Issue (Month): 3 ()
Pages: 279-292

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Handle: RePEc:ijf:ijfiec:v:11:y:2006:i:3:p:279-292

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Web page: http://www.interscience.wiley.com/jpages/1076-9307/

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References

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  1. Andrew G. Haldane & Nicoletta Batini, 1998. "Forward-Looking Rules for Monetary Policy," NBER Working Papers 6543, National Bureau of Economic Research, Inc.
  2. Chadha, Jagjit S & Sarno, Lucio & Valente, Giorgio, 2003. "Monetary Policy Rules, Asset Prices and Exchange Rates," CEPR Discussion Papers 4114, C.E.P.R. Discussion Papers.
  3. Carl Walsh, 2001. "Speed Limit Policies: The Output Gap and Optimal Monetary Policy," CESifo Working Paper Series 609, CESifo Group Munich.
  4. Rudebusch, Glenn D, 2005. "Assessing the Lucas Critique in Monetary Policy Models," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(2), pages 245-72, April.
  5. Orphanides, Athanasios, 2000. "The quest for prosperity without inflation," Working Paper Series 0015, European Central Bank.
  6. Philip Lowe & Claudio Borio, 2002. "Asset prices, financial and monetary stability: exploring the nexus," BIS Working Papers 114, Bank for International Settlements.
  7. Angeloni, Ignazio & Ehrmann, Michael, 2003. "Monetary policy transmission in the euro area: any changes after EMU?," Working Paper Series 0240, European Central Bank.
  8. Bordo, Michael D & Jeanne, Olivier, 2002. "Boom-Busts in Asset Prices, Economic Instability and Monetary Policy," CEPR Discussion Papers 3398, C.E.P.R. Discussion Papers.
  9. Gunnar Bårdsen, 2005. "Stylized dynamic model representations - a note," Working Paper Series 6305, Department of Economics, Norwegian University of Science and Technology.
  10. Svensson, Lars E O, 1998. "Open-Economy Inflation Targeting," CEPR Discussion Papers 1989, C.E.P.R. Discussion Papers.
  11. Gunnar Bårdsen & Eilev S. Jansen & Ragnar Nymoen, 1999. "Econometric Inflation Targeting," Working Paper Series 0502, Department of Economics, Norwegian University of Science and Technology, revised 30 Oct 2001.
  12. Charles Bean, 2003. "Asset Prices, Financial Imbalances and Monetary Policy: Are Inflation Targets Enough?," RBA Annual Conference Volume, in: Anthony Richards & Tim Robinson (ed.), Asset Prices and Monetary Policy Reserve Bank of Australia.
  13. Gunnar Bardsen & Eilev S. Jansen & Ragnar Nymoen, 2004. "Econometric Evaluation of the New Keynesian Phillips Curve," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 66(s1), pages 671-686, 09.
  14. Akram, Q. Farooq, 2006. "PPP in the medium run: The case of Norway," Journal of Macroeconomics, Elsevier, vol. 28(4), pages 700-719, December.
  15. Bardsen, Gunnar & Eitrheim, Oyvind & Jansen, Eilev S. & Nymoen, Ragnar, 2005. "The Econometrics of Macroeconomic Modelling," OUP Catalogue, Oxford University Press, number 9780199246502.
  16. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
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Citations

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Cited by:
  1. Gurdgiev, Constantin T., 2006. "Owner-occupied housing in a model of exchange rate determination," Journal of Housing Economics, Elsevier, vol. 15(3), pages 217-229, September.
  2. Q. Farooq Akram & Ragnar Nymoen, 2009. "Model Selection for Monetary Policy Analysis: How Important is Empirical Validity?," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 71(1), pages 35-68, 02.
  3. Anundsen, André K. & Jansen, Eilev S., 2013. "Self-reinforcing effects between housing prices and credit," Journal of Housing Economics, Elsevier, vol. 22(3), pages 192-212.
  4. Q. Farooq Akram & Yakov Ben-Haim & Øyvind Eitrheim, 2006. "Managing uncertainty through robust-satisficing monetary policy," Working Paper 2006/10, Norges Bank.
  5. Bjørnland, Hilde C., 2005. "Monetary policy and exchange rate interactions in a small open economy," Memorandum 31/2005, Oslo University, Department of Economics.
  6. Francesco Furlanetto, 2008. "Does monetary policy react to asset prices? Some international evidence," Working Paper 2008/07, Norges Bank.
  7. Q. Farooq Akram & Ragnar Nymoen, 2006. "Model selection for monetary policy analysis – Importance of empirical validity," Working Paper 2006/13, Norges Bank.
  8. Pierre-Richard Agénor & K. Alper & Luiz A. Pereira da Silva, 2011. "Capital Regulation, Monetary Policy and Financial Stability," Working Papers Series 237, Central Bank of Brazil, Research Department.
  9. 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.
  10. Lichao Cheng & Yi Jin & Zhixiong Zeng, 2011. "Asset Prices, Monetary Policy, and Aggregate Fluctuations: An Empirical Investigation," Development Research Unit Working Paper Series 13-11, Monash University, Department of Economics.
  11. Dimitrios P Tsomocos & Gunnar Bardsen, 2006. "Evaluation of macroeconomic models for financial stability analysis," Economics Series Working Papers 2006-FE-01, University of Oxford, Department of Economics.
  12. Roger Hammersland & Dag Henning Jacobsen, 2008. "The Financial Accelerator: Evidence using a procedure of Structural Model Design," Discussion Papers 569, Research Department of Statistics Norway.

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