IDEAS home Printed from https://ideas.repec.org/p/tam/wpaper/1715.html
   My bibliography  Save this paper

Stock Market Dynamics and the Central Bank in a General Equilibrium Model

Author

Listed:
  • Ilomaki Jukka
  • Laurila Hannu

    (Faculty of Management, University of Tampere)

Abstract

We introduce a general equilibrium model with potentially inefficient stock markets consisting of asymmetrically informed investors. Prices are sticky in the goods market, but the labor market adjusts perfectly. The central bank aims to maximize the life-time wealth of the households in every period by keeping inflation in the steady state and stock markets in the fair value by adjusting the rate of return on risk-free investments. We find that the “leaning against the wind” policy works, which means that positive stock market bubbles can be eliminated by raising the risk-free rate.

Suggested Citation

  • Ilomaki Jukka & Laurila Hannu, 2017. "Stock Market Dynamics and the Central Bank in a General Equilibrium Model," Working Papers 1715, Tampere University, Faculty of Management and Business, Economics.
    • Handle: RePEc:tam:wpaper:1715
    as

    Download full text from publisher

    File URL: http://urn.fi/URN:ISBN:978-952-03-0459-1
    File Function: First version, 2017
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. 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.
    2. Nouriel Roubini, 2006. "Why Central Banks Should Burst Bubbles," International Finance, Wiley Blackwell, vol. 9(1), pages 87-107, May.
    3. Janet L. Yellen, 2010. "Closing Panel Presentation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(s1), pages 243-248, September.
    4. Adam S. Posen, 2006. "Why Central Banks Should Not Burst Bubbles," International Finance, Wiley Blackwell, vol. 9(1), pages 109-124, May.
    5. J. Tobin, 1958. "Liquidity Preference as Behavior Towards Risk," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 25(2), pages 65-86.
    6. Janet L. Yellen, 2010. "Closing Panel Presentation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(s1), pages 243-248, September.
    7. John R. Conlon, 2015. "Should Central Banks Burst Bubbles? Some Microeconomic Issues," Economic Journal, Royal Economic Society, vol. 125(582), pages 141-161, February.
    8. Svensson, Lars E.O., 2017. "Cost-benefit analysis of leaning against the wind," Journal of Monetary Economics, Elsevier, vol. 90(C), pages 193-213.
    9. Mr. Lars E. O. Svensson, 2016. "Cost-Benefit Analysis of Leaning Against the Wind: Are Costs Larger Also with Less Effective Macroprudential Policy?," IMF Working Papers 2016/003, International Monetary Fund.
    10. Tirole, Jean, 1982. "On the Possibility of Speculation under Rational Expectations," Econometrica, Econometric Society, vol. 50(5), pages 1163-1181, September.
    11. Jukka Ilomäki & Hannu Laurila, 2017. "Real Risk-Free Rate, the Central Bank, and Stock Market Bubbles," Journal of Reviews on Global Economics, Lifescience Global, vol. 6, pages 420-425.
    12. Jordi Gal?, 2014. "Monetary Policy and Rational Asset Price Bubbles," American Economic Review, American Economic Association, vol. 104(3), pages 721-752, March.
    13. John B. Taylor, 2014. "The Role of Policy in the Great Recession and the Weak Recovery," American Economic Review, American Economic Association, vol. 104(5), pages 61-66, May.
    14. Alan Greenspan, 2004. "Risk and Uncertainty in Monetary Policy," American Economic Review, American Economic Association, vol. 94(2), pages 33-40, May.
    15. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, September.
    16. Ilomaki Jukka & Laurila Hannu, 2017. "Endogenous Real Risk-Free Rate, the Central Bank, and Stock Market," Working Papers 1713, Tampere University, Faculty of Management and Business, Economics.
    17. Paul A. Samuelson, 1973. "Proof That Properly Discounted Present Values of Assets Vibrate Randomly," Bell Journal of Economics, The RAND Corporation, vol. 4(2), pages 369-374, Autumn.
    18. Tirole, Jean, 1985. "Asset Bubbles and Overlapping Generations," Econometrica, Econometric Society, vol. 53(6), pages 1499-1528, November.
    19. Charles R. Bean, 2004. "Asset Prices, Financial Instability, and Monetary Policy," American Economic Review, American Economic Association, vol. 94(2), pages 14-18, May.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Jukka Ilomäki & Hannu Laurila, 2021. "Leaning against the wind policy and animal spirits in a general equilibrium model," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 26(2), pages 2325-2334, April.
    2. Ilomaki Jukka & Laurila Hannu, 2017. "Endogenous Real Risk-Free Rate, the Central Bank, and Stock Market," Working Papers 1713, Tampere University, Faculty of Management and Business, Economics.
    3. Chia-Lin Chang & Jukka Ilomäki & Hannu Laurila, 2021. "Leaning against the Bubble: Central Bank Intervention in Walrasian Asset Markets," Risks, MDPI, vol. 9(12), pages 1-12, December.
    4. Akaki Tsomaia, 2021. "Asset bubbles, financial sector, and current challenges to regulatory framework," International Economics and Economic Policy, Springer, vol. 18(4), pages 901-925, October.
    5. repec:hal:spmain:info:hdl:2441/74362fq3f99s299n07e84dlcib is not listed on IDEAS
    6. John Conlon, 2005. "Should Central Banks Burst Bubbles?," Game Theory and Information 0508007, University Library of Munich, Germany.
    7. Kenneth Kuttner, 2011. "Monetary Policy and Asset Price Volatility: Should We Refill the Bernanke-Gertler Prescription?," Department of Economics Working Papers 2011-04, Department of Economics, Williams College, revised Jun 2011.
    8. Christophe Blot & Paul Hubert & Fabien Labondance, 2018. "Monetary Policy and Asset Price Bubbles," Documents de Travail de l'OFCE 2018-37, Observatoire Francais des Conjonctures Economiques (OFCE).
    9. Christophe Blot & Paul Hubert & Fabien Labondance, 2020. "The asymmetric effects of monetary policy on stock price bubbles," SciencePo Working papers Main hal-03403075, HAL.
    10. Jordi Galí, 2016. "Monetary policy and bubbles in a new Keynesian model with overlapping generations," Economics Working Papers 1561, Department of Economics and Business, Universitat Pompeu Fabra, revised Jan 2020.
    11. repec:hal:spmain:info:hdl:2441/3eg9t5b1sb8phpnt79jr73qjr7 is not listed on IDEAS
    12. Clain-Chamosset-Yvrard, Lise & Seegmuller, Thomas, 2015. "Rational bubbles and macroeconomic fluctuations: The (de-)stabilizing role of monetary policy," Mathematical Social Sciences, Elsevier, vol. 75(C), pages 1-15.
    13. Taipalus, Katja, 2006. "Bubbles in the Finnish and US equities markets," Scientific Monographs, Bank of Finland, number 35/2006.
    14. Stijn Claessens & M Ayhan Kose, 2018. "Frontiers of macrofinancial linkages," BIS Papers, Bank for International Settlements, number 95.
    15. repec:zbw:bofism:2012_047 is not listed on IDEAS
    16. Pascal Paul, 2020. "The Time-Varying Effect of Monetary Policy on Asset Prices," The Review of Economics and Statistics, MIT Press, vol. 102(4), pages 690-704, October.
    17. Robert Gmeiner, 2022. "The Chemistry of the Macroeconomy," Journal of Business Cycle Research, Springer;Centre for International Research on Economic Tendency Surveys (CIRET), vol. 18(3), pages 289-313, November.
    18. repec:zbw:bofism:2006_035 is not listed on IDEAS
    19. Taipalus, Katja, 2012. "Detecting asset price bubbles with time-series methods," Scientific Monographs, Bank of Finland, number 2012_047.
    20. Taipalus, Katja, 2012. "Detecting asset price bubbles with time-series methods," Bank of Finland Scientific Monographs, Bank of Finland, volume 0, number sm2012_047.
    21. Hirano, Tomohiro & Inaba, Masaru & Yanagawa, Noriyuki, 2015. "Asset bubbles and bailouts," Journal of Monetary Economics, Elsevier, vol. 76(S), pages 71-89.
    22. Benjamin Eden, 2016. "Should the Fed Increase the Interest Rate to Promote Financial Stability?," Vanderbilt University Department of Economics Working Papers 16-00003, Vanderbilt University Department of Economics.
    23. Altermatt, Lukas, 2019. "Savings, asset scarcity, and monetary policy," Journal of Economic Theory, Elsevier, vol. 182(C), pages 329-359.
    24. Zhang, Mu & Zheng, Jie, 2017. "A robust reference-dependent model for speculative bubbles," Journal of Economic Behavior & Organization, Elsevier, vol. 137(C), pages 232-258.

    More about this item

    Keywords

    interest rate; monetary policy; portfolio choice;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:tam:wpaper:1715. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Sami Remes (email available below). General contact details of provider: https://edirc.repec.org/data/khutafi.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.