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Optimal monetary policy in a new Keynesian model with animal spirits and financial markets

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  • Lengnick, Matthias
  • Wohltmann, Hans-Werner

Abstract

This article presents a macro-finance-interaction model that integrates a NKM with bounded rationality and an agent-based financial market model. We derive four interactive channels between the two sectors where two channels are strictly microfounded. We analyze the impact of the different channels on economic stability and derive optimal (conventional and unconventional) monetary policy rules. We find that coefficients of optimal Taylor rules do not significantly change if financial market stabilization becomes part of the central bank׳s objective function. Additionally, we show that rule-based, backward-looking monetary policy creates huge instabilities if expectations are boundedly rational. Our model is externally validated by showing that it generates fat tailed output growth rates.

Suggested Citation

  • Lengnick, Matthias & Wohltmann, Hans-Werner, 2016. "Optimal monetary policy in a new Keynesian model with animal spirits and financial markets," Journal of Economic Dynamics and Control, Elsevier, vol. 64(C), pages 148-165.
    • Handle: RePEc:eee:dyncon:v:64:y:2016:i:c:p:148-165
    DOI: 10.1016/j.jedc.2016.01.003
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    Keywords

    Agent-based financial markets; New Keynesian macroeconomics; Microfoundation; Optimal monetary policy; Unconventional monetary policy;
    All these keywords.

    JEL classification:

    • E03 - Macroeconomics and Monetary Economics - - General - - - Behavioral Macroeconomics
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles

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