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Optimal Monetary Policy with Wealth Effects

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Author Info
A. Kontonikas ()
A. Montagnoli

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Abstract

This paper analyses optimal monetary policy using a structural model of the economy that allows for the effect of changes in asset prices on aggregate demand. The important feature is that monetary policy is assumed to affect output and inflation not only directly via firms’ level of investment but also via consumption through realized capital gains. Solving the Central Bank’s dynamic optimization problem, we derive an optimal interest rule where nominal interest rates are set according to concurrent inflation and the output gap. When wealth effects are considered though, the optimal response to inflation is lower, as compared to the conventional Taylor rule.

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Publisher Info
Paper provided by Economics and Finance Section, School of Social Sciences, Brunel University in its series Public Policy Discussion Papers with number 02-30.

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Length: 21 pages
Date of creation: Nov 2002
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Handle: RePEc:bru:bruppp:02-30

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Postal: Brunel University, Uxbridge, Middlesex UB8 3PH, UK

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  1. Bennett T. McCallum & Edward Nelson, 1998. "Performance of Operational Policy Rules in an Estimated Semi-Classical Structural Model," NBER Working Papers 6599, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Goodhart, Charles & Hofmann, Boris, 2000. "Financial Variables and the Conduct of Monetary Policy," Working Paper Series 112, Sveriges Riksbank (Central Bank of Sweden). [Downloadable!]
  3. Alexander Ludwig & Torsten Sløk, 2002. "The Impact of Changes in Stock Prices and House Prices on Consumption in OECD Countries," IMF Working Papers 02/1, International Monetary Fund. [Downloadable!]
  4. Laurence Ball, 1997. "Efficient Rules for Monetary Policy," NBER Working Papers 5952, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  5. Jeffrey C. Fuhrer, 1995. "The [un]importance of forward-looking behavior in price specifications," Working Papers 95-6, Federal Reserve Bank of Boston. [Downloadable!]
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  6. Andrew J. Filardo, 2001. "Should monetary policy respond to asset price bubbles? : some experimental results," Research Working Paper RWP 01-04, Federal Reserve Bank of Kansas City. [Downloadable!]
  7. 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. [Downloadable!] (restricted)
  8. Andrew J. Filardo, 2000. "Monetary policy and asset prices," Economic Review, Federal Reserve Bank of Kansas City, issue Q III, pages 11-37. [Downloadable!]
  9. James H. Stock & Mark W. Watson, 2001. "Forecasting output and inflation: the role of asset prices," Proceedings, Federal Reserve Bank of San Francisco, issue Mar. [Downloadable!]
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  10. Randall Morck & Andrei Shleifer & Robert W. Vishny, 1990. "The Stock Market and Investment: Is the Market a Sideshow?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 21(1990-2), pages 157-216. [Downloadable!]
  11. Fama, Eugene F, 1981. "Stock Returns, Real Activity, Inflation, and Money," American Economic Review, American Economic Association, vol. 71(4), pages 545-65, September. [Downloadable!] (restricted)
  12. Conover, C. Mitchell & Jensen, Gerald R. & Johnson, Robert R., 1999. "Monetary environments and international stock returns," Journal of Banking & Finance, Elsevier, vol. 23(9), pages 1357-1381, September. [Downloadable!] (restricted)
  13. Ben Bernanke & Mark Gertler, 1999. "Monetary policy and asset price volatility," Proceedings, Federal Reserve Bank of Kansas City, pages 77-128. [Downloadable!]
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  14. Goodhart, Charles, 2001. "What Weight Should Be Given to Asset Prices in the Measurement of Inflation?," Economic Journal, Royal Economic Society, vol. 111(472), pages F335-56, June. [Downloadable!] (restricted)
  15. Vickers, John, 2000. "Monetary Policy and Asset Prices," Manchester School, University of Manchester, vol. 68(0), pages 1-22, Supplemen. [Downloadable!] (restricted)
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