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The Role of Asset Prices in Best-Practice Monetary Policy

  • Robert Pavasuthipaisit

    (True Corporation)

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    I study the role of asset prices in the conduct of monetary policy under the commitment equilibrium. The findings lend support to the lean-against-the wind strategy in that it is optimal for the central bank to set interest rates to respond to asset-price movements. The gain from responding to asset prices comes from the fact that asset-price movements can provide a signal about the development in the state of the economy. The paper also suggests that prior to and during the subprime mortgage crisis of 2007, it would have been optimal for the Federal Reserve to increase the weight of asset prices in its rate-setting decision.

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    Article provided by International Journal of Central Banking in its journal International Journal of Central Banking.

    Volume (Year): 6 (2010)
    Issue (Month): 2 (June)
    Pages: 81-115

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    Handle: RePEc:ijc:ijcjou:y:2010:q:2:a:4
    Contact details of provider: Web page: http://www.ijcb.org/

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    1. Lars E. O. Svensson & Michael Woodford, 2000. "Indicator variables for optimal policy," Proceedings, Federal Reserve Bank of San Francisco.
    2. Townsend, Robert M., 1979. "Optimal contracts and competitive markets with costly state verification," Journal of Economic Theory, Elsevier, vol. 21(2), pages 265-293, October.
    3. Athanasios Orphanides, 2001. "Monetary Policy Rules Based on Real-Time Data," American Economic Review, American Economic Association, vol. 91(4), pages 964-985, September.
    4. Neiss, Katharine S. & Nelson, Edward, 2003. "The Real-Interest-Rate Gap As An Inflation Indicator," Macroeconomic Dynamics, Cambridge University Press, vol. 7(02), pages 239-262, April.
    5. Sims, Christopher A, 2002. "Solving Linear Rational Expectations Models," Computational Economics, Society for Computational Economics, vol. 20(1-2), pages 1-20, October.
    6. Athanasios Orphanides & Simon Van_Norden, 2000. "The Reliability of Output Gap Estimates in Real Time," Econometric Society World Congress 2000 Contributed Papers 0768, Econometric Society.
    7. Simon Gilchrist & Masashi Saito, 2008. "Expectations, Asset Prices, and Monetary Policy: The Role of Learning," NBER Chapters, in: Asset Prices and Monetary Policy, pages 45-102 National Bureau of Economic Research, Inc.
    8. Orphanides, Athanasios, 2003. "Monetary policy evaluation with noisy information," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 605-631, April.
    9. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
    10. Gilchrist, Simon & Leahy, John V., 2002. "Monetary policy and asset prices," Journal of Monetary Economics, Elsevier, vol. 49(1), pages 75-97, January.
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