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Monetary Policy, Doubts and Asset Prices

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  • Pierpaolo Benigno

    (LUISS and EIEF)

  • Luigi Paciello

    (EIEF)

Abstract

Asset prices and the equity premium might reflect doubts and pessimism. Introducing these features in an otherwise standard New-Keynesian model changes in a quite substantial way its normative conclusions. First, following productivity shocks, optimal policy should be very accommodative even to the point to inflate the equity premium. Second, asset-price movements improve the inflation-output trade-off so that average output can rise without increasing much average inflation. Finally, a strict inflation-targeting policy is dominated by more flexible inflation targeting policies which increase the comovements between inflation, asset prices and output growth.

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Paper provided by Einaudi Institute for Economics and Finance (EIEF) in its series EIEF Working Papers Series with number 1024.

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Length: 35 pages
Date of creation: 2010
Date of revision: Sep 2010
Handle: RePEc:eie:wpaper:1024

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  1. Kai Leitemo & Ulf Söderström, 2005. "Robust monetary policy in the New-Keynesian framework," Macroeconomics, EconWPA 0508032, EconWPA.
  2. Leitemo, Kai & Söderström, Ulf, 2005. "Robust Monetary Policy in a Small Open Economy," CEPR Discussion Papers, C.E.P.R. Discussion Papers 5071, C.E.P.R. Discussion Papers.
  3. Peter J. Klenow & Oleksiy Kryvtsov, 2005. "State-Dependent or Time-Dependent Pricing: Does it Matter for Recent U.S. Inflation?," NBER Working Papers 11043, National Bureau of Economic Research, Inc.
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  5. Aubhik Khan & Robert G. King & Alexander L. Wolman, 2003. "Optimal Monetary Policy," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 70(4), pages 825-860, October.
  6. Pierpaolo Benigno & Michael Woodford, 2008. "Linear-Quadratic Approximation of Optimal Policy Problems," Discussion Papers, Columbia University, Department of Economics 0809-01, Columbia University, Department of Economics.
  7. Pierpaolo Benigno & Michael Woodford, 2004. "Inflation stabilization and welfare: The case of a distorted steady state," Discussion Papers, Columbia University, Department of Economics 0405-04, Columbia University, Department of Economics.
  8. Dupor, Bill, 2005. "Stabilizing non-fundamental asset price movements under discretion and limited information," Journal of Monetary Economics, Elsevier, Elsevier, vol. 52(4), pages 727-747, May.
  9. William Poole, 2007. "Understanding the Fed," Review, Federal Reserve Bank of St. Louis, Federal Reserve Bank of St. Louis, issue Jan, pages 3-14.
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  13. Giannoni, Marc P., 2002. "Does Model Uncertainty Justify Caution? Robust Optimal Monetary Policy In A Forward-Looking Model," Macroeconomic Dynamics, Cambridge University Press, Cambridge University Press, vol. 6(01), pages 111-144, February.
  14. Lars Peter Hansen & Thomas J. Sargent, 2007. "Introduction to Robustness," Introductory Chapters, Princeton University Press, Princeton University Press.
  15. Glenn D. Rudebusch, 1999. "Is the Fed too timid? Monetary policy in an uncertain world," Working Papers in Applied Economic Theory, Federal Reserve Bank of San Francisco 99-05, Federal Reserve Bank of San Francisco.
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Cited by:
  1. Frank Hespeler & Marco M. Sorge, 2013. "Does Near-Rationality Matter in First-Order Approximate Solutions? A Perturbation Approach," CSEF Working Papers, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy 339, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
  2. Adam, Klaus & Woodford, Michael, 2012. "Robustly Optimal Monetary Policy in a Microfounded New Keynesian Model," CEPR Discussion Papers, C.E.P.R. Discussion Papers 8826, C.E.P.R. Discussion Papers.
  3. Vicente da Gama Machado, 2012. "Monetary Policy, Asset Prices and Adaptive Learning," Working Papers Series, Central Bank of Brazil, Research Department 274, Central Bank of Brazil, Research Department.

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