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Monetary policy and stock-price dynamics in a DSGE framework

  • Nisticò, Salvatore

This paper analyzes the role of stock prices in driving monetary policy for price stability in a non-Ricardian DSGE model. It shows that the dynamics of the interest rate consistent with price stability requires a response to stock-price changes that depends on the shock driving them: a supply shock (e.g. productivity) does not require an additional, dedicated response relative to the standard Representative-Agent framework, while a demand shock does. Moreover, we show that implementing the flexible-price allocation by means of an interest-rate rule that reacts to deviations of the stock-price level from the flexible-price equilibrium incurs risks of endogenous instability that are the higher the less profitable on average equity shares. On the other hand, reacting to the stock-price growth rate is risk-free from the perspective of equilibrium determinacy, and can be beneficial from an overall real stability perspective.

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Article provided by Elsevier in its journal Journal of Macroeconomics.

Volume (Year): 34 (2012)
Issue (Month): 1 ()
Pages: 126-146

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Handle: RePEc:eee:jmacro:v:34:y:2012:i:1:p:126-146
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/622617

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