Dor, Eric (UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES); Université catholique de Lille, Faculté Libre des Sciences Economiques, Institut d’Economie Scientifique et de Gestion IESEG, Labores-CNRS) Durré, Alain () (UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES))
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This paper attempts to model the relationship between monetary policy and financial asset prices. We develop an aggregative model under forward-looking rational expectations to analyse the optimal monetary policy response to stock prices and exchange rates shocks. We first demonstrate that a model ignoring the impact of equity prices and exchange rates on aggregate demand leads to an overestimation of the optimal policy response to standard shocks. Second, we clearly point out that a correct assessment of the relation between optimal monetary policy and either equity prices or exchange rates necessitates a model including both kinds of financial prices simultaneously. Third, we show how these interactions between financial asset prices and monetary policy are affected by a particular form of coordination between monetary policy and fiscal policy, arising from a public debt solvency constraint.
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Find related papers by JEL classification: E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Determination of Interest Rates; Term Structure of Interest Rates E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies
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