Asset Price and Monetary Policy - The Effect of Expectation Formation
AbstractThis paper is a theoretical study of the effects of monetary policy reacting to fluctuations in asset price, accounting for the expectation formation effect of policy regime shift in a DSGE model calibrated to the U.S. economy. We find that the effect of expectation formation can substantially influence the movement of asset price. In contrast to the linear policy rule, under the regime switching policy rule reacting to asset price can generate substantial stabilization effect: the "expected" inflation-output volatility frontier shifts downward, thereby lowering both the volatilities of inflation and output for all possible policy choices. The trade-off between the expected volatility of inflation and that of output, as demonstrated by the "Taylor curve," greatly diminishes, implying that the Taylor rule which considers expectation formation effect and asset price movement expands the set of monetary policy choices available for monetary authority.
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Bibliographic InfoPaper provided by Hong Kong Institute for Monetary Research in its series Working Papers with number 032011.
Length: 41 pages
Date of creation: Jan 2011
Date of revision:
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Asset Price; Monetary Policy; Regime Switching; DSGE;
Find related papers by JEL classification:
- E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
- G1 - Financial Economics - - General Financial Markets
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-03-05 (All new papers)
- NEP-CBA-2011-03-05 (Central Banking)
- NEP-MAC-2011-03-05 (Macroeconomics)
- NEP-MON-2011-03-05 (Monetary Economics)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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