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Should Monetary Policy Respond to Asset Price Misalignments?

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  • Alexandros Kontonikas

    ()

  • Christos Ioannidis

Abstract

This paper analyses the relationship between monetary policy and asset prices using a structural rational expectations model that allows for the effect of asset prices on aggregate demand. We assume that asset prices follow a partial adjustment mechanism whereas they are positively affected by past changes, thus allowing for ‘momentum trading’, while at the same time we allow for reversion towards fundamentals. We then conduct stochastic simulations using two alternative monetary policy rules, inflation-forecast targeting and the standard Taylor rule. The results indicate that, under both rules, interest rate setting that takes into account asset price misalignments leads to lower overall macroeconomic volatility, as measured by the postulated loss function of the central bank.

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Bibliographic Info

Paper provided by Economics and Finance Section, School of Social Sciences, Brunel University in its series Public Policy Discussion Papers with number 03-19.

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Length: 24 pages
Date of creation: Jun 2003
Date of revision:
Handle: RePEc:bru:bruppp:03-19

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

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Citations

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Cited by:
  1. Q. Farooq Akram & Øyvind Eitrheim, 2006. "Flexible inflation targeting and financial stability: Is it enough to stabilise inflation and output?," Working Paper 2006/07, Norges Bank.
  2. Fiodendji, Komlan, 2011. "Should Canadian Monetary Policy Respond to Asset Prices? Evidence from a Structural Model," MPRA Paper 27942, University Library of Munich, Germany.
  3. Lengnick, Matthias & Wohltmann, Hans-Werner, 2011. "Agent-based financial markets and New Keynesian macroeconomics: A synthesis," Economics Working Papers 2011,09, Christian-Albrechts-University of Kiel, Department of Economics.
  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. Pierre-Richard Agénor & Luiz A. Pereira da Silva, 2013. "Inflation Targeting and Financial Stability: A Perspective from the Developing World," Working Papers Series 324, Central Bank of Brazil, Research Department.
  6. Romaniuk, Katarzyna, 2006. "What if the Fed increased the weight of the stock price gap in its reaction function?," Journal of Policy Modeling, Elsevier, vol. 28(7), pages 725-737, October.
  7. Meixing DAI & Eleftherios SPYROMITROS, 2008. "Monetary policy, asset prices and model uncertainty," Working Papers of BETA 2008-15, Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg.
  8. Ioannidis, Christos & Kontonikas, Alexandros, 2008. "The impact of monetary policy on stock prices," Journal of Policy Modeling, Elsevier, vol. 30(1), pages 33-53.
  9. 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.
  10. Alexandros Kontonikas & Alberto Montagnoli & Nicola Spagnolo, 2006. "Stock Returns and Inflation: The Impact of Inflation Targeting," Working Papers 2005_11, Business School - Economics, University of Glasgow.
  11. Bask, Mikael, 2009. "Monetary Policy, Stock Price Misalignments and Macroeconomic Instability," Working Papers 540, Hanken School of Economics.
  12. J. Rodrigo Fuentes S. & Marcelo Ochoa C., 2007. "Política Monetaria, Precios de Activos y Estabilidad Financiera: Una Revisión de la Literatura," Notas de Investigación Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 10(3), pages 115-127, December.

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