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Asset Prices, Monetary Policy and Determinacy

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  • Singh, Aarti
  • Stone, Sophie

Abstract

We study whether central banks should respond to asset prices in their policy rules. Using a modified version of Bernanke, Gertler and Gilchrist's (1999) model—a standard dynamic stochastic general equilibrium New Keynesian model with a financial accelerator effect—we explore how equilibrium determinacy is impacted when the central bank reacts to asset prices. Our results indicate that by reacting to asset price movements in its Taylor-type nominal interest rate feedback rule, a central bank makes determinacy of the rational expectations equilibrium more likely relative to a standard policy rule where the central bank does not react to asset prices.

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Bibliographic Info

Paper provided by University of Sydney, School of Economics in its series Working Papers with number 2012-06.

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Date of creation: Mar 2012
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Handle: RePEc:syd:wpaper:2123/8187

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Postal: Sydney, NSW 2006
Phone: 61 +2 9351 5055
Fax: 61 +2 9351 4341
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Web page: http://sydney.edu.au/arts/economics
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Related research

Keywords: financial accelerator; determinacy; monetary policy; Asset prices;

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References

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  1. Ben Bernanke & Mark Gertler, 1999. "Monetary policy and asset price volatility," Economic Review, Federal Reserve Bank of Kansas City, issue Q IV, pages 17-51.
  2. Rodrigo Caputo & Juan Pablo Medina & Claudio Soto., 2010. "The Financial Accelerator Under Learning and The Role of Monetary Policy," Working Papers Central Bank of Chile 590, Central Bank of Chile.
  3. Gilchrist, Simon & Leahy, John V., 2002. "Monetary policy and asset prices," Journal of Monetary Economics, Elsevier, vol. 49(1), pages 75-97, January.
  4. Honkapohja, S. & Mitra, K., 2001. "Are Non-Fundamental Equilibria Learnable in Models of Monetary Policy?," University of Helsinki, Department of Economics 501, Department of Economics.
  5. Julio J. Rotemberg & Michael Woodford, 1998. "Interest-Rate Rules in an Estimated Sticky Price Model," NBER Working Papers 6618, National Bureau of Economic Research, Inc.
  6. Charles T. Carlstrom & Timothy S. Fuerst, 2003. "Investment and interest rate policy: a discrete time analysis," Working Paper 0320, Federal Reserve Bank of Cleveland.
  7. Stephen G. Cecchetti & Marion Kohler & Christian Upper, 2009. "Financial crises and economic activity," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 89-135.
  8. McCallum, Bennett T., 1999. "Issues in the design of monetary policy rules," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 23, pages 1483-1530 Elsevier.
  9. 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.
  10. James Bullard & Kaushik Mitra, 2002. "Learning about monetary policy rules," Working Papers 2000-001, Federal Reserve Bank of St. Louis.
  11. 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.
  12. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  13. 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.
  14. Michael Woodford, 2001. "The Taylor Rule and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 91(2), pages 232-237, May.
  15. 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.
  16. Yasuo Hirose, 2008. "Equilibrium Indeterminacy and Asset Price Fluctuation in Japan: A Bayesian Investigation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(5), pages 967-999, 08.
  17. Sims, Christopher A, 2002. "Solving Linear Rational Expectations Models," Computational Economics, Society for Computational Economics, vol. 20(1-2), pages 1-20, October.
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Citations

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Cited by:
  1. Lise Clain-Chamosset-Yvrard & Thomas Seegmuller, 2012. "Rational Bubbles and Macroeconomic Fluctuations. The(De-)Stabilizing Role of Monetary Policy," AMSE Working Papers 1207, Aix-Marseille School of Economics, Marseille, France, revised 23 Mar 2012.
  2. 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.

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