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Stock prices and monetary policy: Re-examining the issue in a New Keynesian model with endogenous investment

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  • Grossi, Michele
  • Tamborini, Roberto

Abstract

In this paper, the authors present a New Keynesian quantitative model with endogenous investment and a stock-market sector to shed further light on two unsettled issues: whether central banks should include some financial indicator in their policy rules, and what indicator may be expected to generate better stabilization performance. For comparative purposes, the authors replicate the policy framework and assessment strategy of the well-known no-inclusion model of Bernanke-Gertler (1999, 2000) and assess performance of five policy rules. Two of these are traditional Taylor rules (i.e., do not incorporate financial indicators) that differ in the relative weight they put on output and inflation gaps. The other three are financial Taylor rules. These involve the addition of one financial indicator in each case. Specifically, the deviation from trend of stock prices, of Tobin's q (the rate of change in stock prices relative to capital stock) and of investment. The authors obtain results that are at variance with Bernanke-Gertler, first, because the best performing rule of the traditional rules is output aggressive instead of inflation aggressive and, second, because the financial rule with Tobin's q outperforms the traditional inflation-aggressive one under all dimensions and cases. However, the authors cannot draw a univocal conclusion as regards the comparison between the financial rule with Tobin's q and the traditional but output aggressive rule. --

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Bibliographic Info

Paper provided by Kiel Institute for the World Economy in its series Economics Discussion Papers with number 2011-54.

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Date of creation: 2011
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Handle: RePEc:zbw:ifwedp:201154

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Keywords: New Keynesian models; monetary policy; stock markets and bubbles;

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  1. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
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Cited by:
  1. Ronny Mazzocchi, 2013. "Intertemporal Coordination Failure and Monetary Policy," DEM Discussion Papers 2013/15, Department of Economics and Management.
  2. Friedman, Benjamin M., 2012. "Rules versus discretion at the Federal Reserve System: On to the second century," Journal of Macroeconomics, Elsevier, vol. 34(3), pages 608-615.

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