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Liquidity and Asset Prices: How Strong Are the Linkages?

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  • Christian Dreger
  • Jürgen Wolters

Abstract

The appropriate design of monetary policy in integrated financial markets is one of the most challenging areas for central banks. One hot topic is whether the rise in liquidity in recent years has contributed to the formation of price bubbles in asset markets. If strong linkages exist, the inclusion of asset prices in the monetary policy rule can eventually limit speculative runs and negative effects on the real economy in the future. We explore the impacts of liquidity shocks on real share and house prices and the influence of wealth prices on liquidity. VAR models are specified for the US and the euro area. To control for international spillovers, global VARs are also considered. Differences in the results can provide a measure on the impact of financial market integration. The specifications point to some impact of liquidity shocks on house prices, while asset prices are not affected.

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File URL: http://www.diw.de/documents/publikationen/73/diw_01.c.94897.de/dp860.pdf
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Bibliographic Info

Paper provided by DIW Berlin, German Institute for Economic Research in its series Discussion Papers of DIW Berlin with number 860.

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Length: 17 p.
Date of creation: 2009
Date of revision:
Handle: RePEc:diw:diwwpp:dp860

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Keywords: Liquidity shocks; asset prices; GVAR analysis; monetary policy;

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Cited by:
  1. Christian Dreger & Jürgen Wolters, 2011. "Money and Inflation in the Euro Area during the Financial Crisis," Discussion Papers of DIW Berlin 1131, DIW Berlin, German Institute for Economic Research.
  2. Alexander Chudik & Hashem Pesaran, 2014. "Theory and Practice of GVAR Modeling," Cambridge Working Papers in Economics 1408, Faculty of Economics, University of Cambridge.
  3. Christian Pierdzioch, 2012. "Macroeconomic Factors and the German Real Estate Market: A Stock-Market-Based Forecasting Experiment," Review of Economics & Finance, Better Advances Press, Canada, vol. 2, pages 87-96, May.
  4. Alexander Chudik & M. Hashem Pesaran, 2014. "Theory and Practice of GVAR Modeling," CESifo Working Paper Series 4807, CESifo Group Munich.

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