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Financial Variables and the Conduct of Monetary Policy

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  • Goodhart, Charles

    (London School of Economics)

  • Hofmann, Boris

    (Zentrum für Europäische Integrationsforschung)

Abstract

This paper analyses the role of financial variables in the conduct of monetary policy. In the baseline model for the analysis of interest rules, the inflation rate depends on the output gap, which is solely determined by its own lags and the lagged short-term real interest rate. However, from a theoretical point of view there are several other financial variables which may affect aggregate demand, and should therefore be taken into account in the estimation of an output gap equation. In order to assess the importance of financial variables such as asset prices and monetary aggregates for aggregate demand, we estimate a small structural model for 17 developed countries using quarterly data spanning 1973 - 1998. The results indicate that the effect of other financial variables, especially property and share prices, on the output gap is highly significant. It appears that in almost all of the countries in our data set it is necessary to control for the effect of other financial variables on the output gap in order to find a significant effect for monetary policy.

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Bibliographic Info

Paper provided by Sveriges Riksbank (Central Bank of Sweden) in its series Working Paper Series with number 112.

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Length: 23 pages
Date of creation: 01 Nov 2000
Date of revision:
Handle: RePEc:hhs:rbnkwp:0112

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Keywords: Monetary policy; Financial Variables;

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  1. Rudebusch, Glenn D & Svensson, Lars E O, 1998. "Policy Rules for Inflation Targeting," CEPR Discussion Papers 1999, C.E.P.R. Discussion Papers.
  2. Hiroshi Shibuya, 1992. "Dynamic Equilibrium Price Index: Asset Price and Inflation," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 10(1), pages 95-109, February.
  3. 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.
  4. Shigenori Shiratsuka, 1999. "Asset price fluctuation and price indices," Working Paper Series WP-99-9, Federal Reserve Bank of Chicago.
  5. Ben Bernanke & Mark Gertler, 2000. "Monetary Policy and Asset Price Volatility," NBER Working Papers 7559, National Bureau of Economic Research, Inc.
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