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Fundamental Paper Wealth and Monetary Policy

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  • Junning Cai

    (University of Hawaii at Manoa)

Abstract

This paper articulates three insights regarding asset prices and monetary policy: (1) Asset price appreciation due to monetary expansion, despite its “paper” wealth nature, tends to make current consumers as a whole wealthier; (2) the wealth effect of monetary policy (on consumption) is negatively correlated with Tobin’s q effect (on investment), which positively depends on investment elasticity; and (3) the soundness of asset market performances does not depend on whether they are fundamental or not, but on their compatibility with the AD-AS balance in the long run. These basic insights and their implications reveal some limitations of monetary policy as a stabilization policy, clarify some misperceptions on fundamental asset prices, and provide a rationale for monetary policy to react directly to asset market performances.

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File URL: http://128.118.178.162/eps/mac/papers/0309/0309001.pdf
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Bibliographic Info

Paper provided by EconWPA in its series Macroeconomics with number 0309001.

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Length: 46 pages
Date of creation: 01 Sep 2003
Date of revision:
Handle: RePEc:wpa:wuwpma:0309001

Note: Type of Document - pdf; prepared on pc; to print on HP/PostScript/Franciscan monk; pages: 46; figures: included
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Web page: http://128.118.178.162

Related research

Keywords: Fundamental Paper Wealth; Wealth Effect; Bubbles; Monetary Policy;

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  1. Stephen G. Cecchetti & Anil K Kashyap, 1995. "International Cycles," NBER Working Papers 5310, National Bureau of Economic Research, Inc.
  2. 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.
  3. Tobin, James, 1969. "A General Equilibrium Approach to Monetary Theory," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 1(1), pages 15-29, February.
  4. Ben Bernanke & Mark Gertler & Simon Gilchrist, 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," NBER Working Papers 6455, National Bureau of Economic Research, Inc.
  5. Douglas W. Elmendorf, 1996. "The effect of interest-rate changes on household saving and consumption: a survey," Finance and Economics Discussion Series 96-27, Board of Governors of the Federal Reserve System (U.S.).
  6. Andrew B. Abel & Janice C. Eberly, . "An Exact Solution for the Investment and Market Value of a Firm Facing Uncertainty, Adjustment Costs, and Irreversibility," Rodney L. White Center for Financial Research Working Papers 12-93, Wharton School Rodney L. White Center for Financial Research.
  7. Olivier J. Blanchard, 1984. "Debt, Deficits and Finite Horizons," NBER Working Papers 1389, National Bureau of Economic Research, Inc.
  8. Norman Loayza & Klaus Schmidt-Hebbel, 2002. "Monetary Policy Functions and Transmission Mechanisms: An Overview," Central Banking, Analysis, and Economic Policies Book Series, in: Norman Loayza & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series (ed.), Monetary Policy: Rules and Transmission Mechanisms, edition 1, volume 4, chapter 1, pages 001-020 Central Bank of Chile.
  9. Michael D. Bordo & Olivier Jeanne, 2002. "Boom-Busts in Asset Prices, Economic Instability, and Monetary Policy," NBER Working Papers 8966, National Bureau of Economic Research, Inc.
  10. Ben Bernanke & Mark Gertler, 2000. "Monetary Policy and Asset Price Volatility," NBER Working Papers 7559, National Bureau of Economic Research, Inc.
  11. Stephen G. Cecchetti & Hans Genberg & Sushil Wadhwani, 2002. "Asset Prices in a Flexible Inflation Targeting Framework," NBER Working Papers 8970, National Bureau of Economic Research, Inc.
  12. Abel, Andrew B. & Eberly, Janice C., 1997. "An exact solution for the investment and value of a firm facing uncertainty, adjustment costs, and irreversibility," Journal of Economic Dynamics and Control, Elsevier, vol. 21(4-5), pages 831-852, May.
  13. King, R.G., 1989. "Value And Capital - In The Equilibrium Business Cycle Program," RCER Working Papers 207, University of Rochester - Center for Economic Research (RCER).
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Cited by:
  1. Junning Cai, 2004. "Liquidity Trap Prevention and Escape: A Simple Proposition," Macroeconomics 0402033, EconWPA.
  2. Junning Cai & Byron Gangnes, 2004. "Open Capital Account: Concrete Wealth or Paper Wealth," International Finance 0401002, EconWPA.

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