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Monetary Policy, Doubts and Asset Prices

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  • Pierpaolo Benigno
  • Luigi Paciello

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 the nature of the policy that maximizes the welfare of the consumers in the model. First, following productivity shocks, optimal policy in this model is more accommodating than in a standard New-Keynesian model, and may even 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 may result in lower average welfare than a more flexible inflation-targeting policy, which instead increases the comovements between inflation, asset prices and output growth.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16386.

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Date of creation: Sep 2010
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Handle: RePEc:nbr:nberwo:16386

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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. 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.
  4. 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.
  5. Thomas Tallarini, . "Risk-Sensitive Real Business Cycles," GSIA Working Papers, Carnegie Mellon University, Tepper School of Business 1997-35, Carnegie Mellon University, Tepper School of Business.
  6. 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.
  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. William Poole, 2007. "Understanding the Fed," Review, Federal Reserve Bank of St. Louis, Federal Reserve Bank of St. Louis, issue Jan, pages 3-14.
  9. 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.
  10. Tetlow, Robert J., 2007. "On the robustness of simple and optimal monetary policy rules," Journal of Monetary Economics, Elsevier, Elsevier, vol. 54(5), pages 1397-1405, July.
  11. Andrew T. Levin & J. David López-Salido & Edward Nelson & Tack Yun, 2008. "Macroeconometric equivalence, microeconomic dissonance, and the design of monetary policy," Working Papers, Federal Reserve Bank of St. Louis 2008-035, Federal Reserve Bank of St. Louis.
  12. Dennis, Richard & Leitemo, Kai & Söderström, Ulf, 2007. "Monetary Policy in a Small Open Economy with a Preference for Robustness," CEPR Discussion Papers, C.E.P.R. Discussion Papers 6067, C.E.P.R. Discussion Papers.
  13. Lars Peter Hansen & Thomas J. Sargent, 2007. "Introduction to Robustness," Introductory Chapters, Princeton University Press, Princeton University Press.
  14. 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.
  15. Smets, Frank & Wouters, Rafael, 2007. "Shocks and Frictions in US Business Cycles: A Bayesian DSGE Approach," CEPR Discussion Papers, C.E.P.R. Discussion Papers 6112, C.E.P.R. Discussion Papers.
  16. 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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