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Learning, Monetary Policy and Asset Prices

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  • Airaudo, Marco

    ()
    (Department of Economics & International Business, LeBow College of Business, Drexel University)

  • Nisticò, Salvatore

    ()
    (Universit‡ degli Studi di Roma "La Sapienza" and LUISS Guido Carli)

  • Zanna, Luis-Felipe

    ()
    (Research Department, International Monetary Fund)

Abstract

We assess the conditions under which an interest rate rule granting an explicit response to stock prices can shield the economy against endogenous aggregate instability in the form of fluctuations driven by self-fulfilling beliefs, and fundamental equilibria that are not learnable in the Expectational Stability sense of Evans and Honkapohja (2001). To do so, we use a New-Keynesian DSGE model populated by Blanchard-Yaari non-Ricardian households. The constant turnover between long-time traders (holding assets) and newcomers (entering the market with no wealth at all) implies that the wedge between current and expected future aggregate consumption is affected by the market value of financial wealth, making stock prices non-redundant for the business cycle. We find that such policy is prone to generate non-fundamental fluctuations or fundamental fluctuations that are not learnable, unless both the turnover rate in markets and average profitability from investing in risky equity are significantly large. However, this appears to be the exception for most reasonable model calibrations, implying that, absent additional frictions, a systematic response to stock prices by monetary policy remains a bad idea in the New-Keynesian paradigm.

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Bibliographic Info

Paper provided by LeBow College of Business, Drexel University in its series School of Economics Working Paper Series with number 2012-12.

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Length: 40 pages
Date of creation: 08 Feb 2012
Date of revision:
Handle: RePEc:ris:drxlwp:2012_012

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Web page: http://www.lebow.drexel.edu/
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Keywords: Learning; Expectational Stability; Interest Rate Rules; Multiple Equilibria; Determinacy; Stock Prices;

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References

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Citations

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Cited by:
  1. Gilles Dufrénot & Anwar Khayat, 2014. "Monetary Policy Switching in the Euro Area and Multiple Equilibria: An Empirical Investigation," AMSE Working Papers 1408, Aix-Marseille School of Economics, Marseille, France, revised Jan 2014.
  2. Salvatore Nisticò, 2012. "Monetary Policy and Stock-Price Dynamics in a DSGE Framework," CSEF Working Papers 307, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
  3. Muhammad Ali Nasir & Alaa M. Soliman, 2014. "Aspects of Macroeconomic Policy Combinations and Their Effects on Financial Markets," Economic Issues Journal Articles, Economic Issues, vol. 19(1), pages 95-118, March.
  4. Tiziana Assenza & Michele Berardi & Domenico Delli Gatti, 2011. "Was Bernanke Right? Targeting Asset Prices may not be a Good Idea after all," CESifo Working Paper Series 3641, CESifo Group Munich.
  5. Vicente da Gama Machado, 2012. "Monetary Policy, Asset Prices and Adaptive Learning," Working Papers Series 274, Central Bank of Brazil, Research Department.
  6. Fabio Milani, 2008. "Learning about the Interdependence between the Macroeconomy and the Stock Market," Working Papers 070819, University of California-Irvine, Department of Economics.
  7. Benjamin Carton, 2012. "Monetary-Policy Tradeoff in Overlapping Generations DSGE Models," DEM Working Papers Series 028, University of Pavia, Department of Economics and Management.

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