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Determinacy, Stock Market Dynamics and Monetary Policy Inertia

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  • Damjan Pfajfar

    (Tilburg University)

  • Emiliano Santoro

    (Department of Economics, University of Copenhagen)

Abstract

This note deals with the stability properties of an economy where the central bank is concerned with stock market developments. We introduce a Taylor rule reacting to stock price growth rates along with inflation and output gap in a New-Keynesian setup. We explore the performance of this rule from the vantage of equilibrium uniqueness. We show that this reaction function is isomorphic to a rule with an interest rate smoothing term, whose magnitude increases in the degree of aggressiveness towards asset prices growth. As shown by Bullard and Mitra (2007, Determinacy, learnability, and monetary policy inertia, Journal of Money, Credit and Banking 39, 1177-1212) this feature of monetary policy inertia can help at alleviating problems of indeterminacy.

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Bibliographic Info

Paper provided by University of Copenhagen. Department of Economics in its series Discussion Papers with number 08-30.

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Length: 8 pages
Date of creation: Nov 2008
Date of revision:
Handle: RePEc:kud:kuiedp:0830

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Keywords: monetary policy; asset prices; rational expectation equilibrium uniqueness;

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References

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  1. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
  2. Charles T. Carlstrom & Timothy S. Fuerst, 2004. "Asset prices, nominal rigidities, and monetary policy," Working Paper 0413, Federal Reserve Bank of Cleveland.
  3. Bennett T. McCallum, 1997. "Issues in the Design of Monetary Policy Rules," NBER Working Papers 6016, National Bureau of Economic Research, Inc.
  4. James Bullard & Kaushik Mitra, . "Determinacy, Learnability, and Monetary Policy Inertia," Discussion Papers 00/43, Department of Economics, University of York.
  5. Ben Bernanke & Mark Gertler, 2000. "Monetary Policy and Asset Price Volatility," NBER Working Papers 7559, National Bureau of Economic Research, Inc.
  6. Ben S. Bernanke & Mark Gertler, 2001. "Should Central Banks Respond to Movements in Asset Prices?," American Economic Review, American Economic Association, vol. 91(2), pages 253-257, May.
  7. Julio J. Rotemberg & Michael Woodford, 1998. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy: Expanded Version," NBER Technical Working Papers 0233, National Bureau of Economic Research, Inc.
  8. Glenn D. Rudebusch, 2005. "Monetary policy inertia: fact or fiction?," Working Paper Series 2005-19, Federal Reserve Bank of San Francisco.
  9. Julio J. Rotemberg & Michael Woodford, 1999. "Interest Rate Rules in an Estimated Sticky Price Model," NBER Chapters, in: Monetary Policy Rules, pages 57-126 National Bureau of Economic Research, Inc.
  10. Rudebusch, Glenn D., 1995. "Federal Reserve interest rate targeting, rational expectations, and the term structure," Journal of Monetary Economics, Elsevier, vol. 35(2), pages 245-274, April.
  11. Michael Woodford, 1999. "Optimal monetary policy inertia," Proceedings, Federal Reserve Bank of San Francisco.
  12. Bullard, James & Mitra, Kaushik, 2002. "Learning about monetary policy rules," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1105-1129, September.
  13. Giorgio Di Giorgio & Salvatore Nistico, 2007. "Monetary Policy and Stock Prices in an Open Economy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(8), pages 1947-1985, December.
  14. James B. Bullard & Eric Schaling, 2002. "Why the Fed should ignore the stock market," Review, Federal Reserve Bank of St. Louis, issue Mar., pages 35-42.
  15. Michael Woodford, 2003. "Optimal Interest-Rate Smoothing," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 861-886.
  16. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
  17. Michael Woodford, 2001. "The Taylor Rule and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 91(2), pages 232-237, May.
  18. Pfajfar, D. & Santoro, E., 2012. "Credit Market Distortions, Asset Prices and Monetary Policy," Discussion Paper 2012-010, Tilburg University, Center for Economic Research.
  19. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-11, July.
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Citations

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Cited by:
  1. Ravn, Søren Hove, 2014. "Asymmetric monetary policy towards the stock market: A DSGE approach," Journal of Macroeconomics, Elsevier, vol. 39(PA), pages 24-41.
  2. Pfajfar, D. & Santoro, E., 2012. "Credit Market Distortions, Asset Prices and Monetary Policy," Discussion Paper 2012-010, Tilburg University, Center for Economic Research.
  3. Airaudo, Marco & Cardani, Roberta & Lansing, Kevin J., 2013. "Monetary policy and asset prices with belief-driven fluctuations," Journal of Economic Dynamics and Control, Elsevier, vol. 37(8), pages 1453-1478.
  4. Airaudo, Marco, 2013. "Monetary policy and stock price dynamics with limited asset market participation," Journal of Macroeconomics, Elsevier, vol. 36(C), pages 1-22.
  5. Airaudo, Marco, 2013. "Monetary policy, stock prices, and consumption externalities," Economics Letters, Elsevier, vol. 120(3), pages 537-541.

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