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The Monetary Policy Implications of Behavioral Asset Bubbles

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ap Gwilym, Rhys

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Abstract

I introduce behavioral asset pricing rules into a wider dynamic stochastic general equilibrium framework. Asset price bubbles emerge endogenously within the model. I find that in this model the only monetary policy that would be likely to enhance welfare is a counter-intuitive 'running with the wind' policy. I conclude that the optimal policy is highly dependent on the nature of the behavioral rules that are stipulated. Given that monetary authorities have limited information about the ways in which agents actually behave, a systematic monetary policy response to asset price misalignments is unlikely to enhance welfare.

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Paper provided by Cardiff University, Cardiff Business School, Economics Section in its series Cardiff Economics Working Papers with number E2009/18.

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Length: 39 pages
Date of creation: Sep 2009
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Handle: RePEc:cdf:wpaper:2009/18

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  1. 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. [Downloadable!] (restricted)
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  2. Katrin Assenmacher-Wesche & Stefan Gerlach, 2008. "Ensuring financial stability: financial structure and the impact of monetary policy on asset prices," IEW - Working Papers iewwp361, Institute for Empirical Research in Economics - IEW. [Downloadable!]
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  3. Frankel, Jeffrey A & Froot, Kenneth A, 1990. "Chartists, Fundamentalists, and Trading in the Foreign Exchange Market," American Economic Review, American Economic Association, vol. 80(2), pages 181-85, May. [Downloadable!] (restricted)
  4. Ben Bernanke & Mark Gertler, 2000. "Monetary Policy and Asset Price Volatility," NBER Working Papers 7559, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  5. Charles R. Bean, 2004. "Asset Prices, Financial Instability, and Monetary Policy," American Economic Review, American Economic Association, vol. 94(2), pages 14-18, May. [Downloadable!]
  6. Le, Vo Phuong Mai & Minford, Patrick & Wickens, Michael, 2008. "How much nominal rigidity is there in the US economy? Testing a New Keynesian DSGE Model using indirect inference," Cardiff Economics Working Papers E2008/32, Cardiff University, Cardiff Business School, Economics Section, revised Oct 2009. [Downloadable!]
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  7. Robert E. Lucas, 2003. "Macroeconomic Priorities," American Economic Review, American Economic Association, vol. 93(1), pages 1-14, March. [Downloadable!]
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