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Welfare analysis of non-fundamental asset price and investment shocks: implications for monetary policy

In: Investigating the relationship between the financial and real economy

Author

Listed:
  • Frank Smets

    (European Central Bank)

  • Raf Wouters

    (National Bank of Belgium)

Abstract

Using a sticky price-wage model with capital accumulation and adjustment costs, this paper analyses the welfare effects of non-fundamental asset price and investment fluctuations for the representative household. The welfare effect depends strongly on the steady state level around which the economy is fluctuating. If output is below the first best competitive equilibirum because of the existence of markups in a monopolisitc competitive environment, asset price booms and the resulting positive investment and demand effects move the economy in the direction of the efficient output and can therefore be welfare improving. In such a case, optimal monetary policy will no longer be characterised by a symmetric response to inflation and output movements around the steady state, but will typically need to adjust asymmetrically
(This abstract was borrowed from another version of this item.)

Suggested Citation

  • Frank Smets & Raf Wouters, 2005. "Welfare analysis of non-fundamental asset price and investment shocks: implications for monetary policy," BIS Papers chapters,in: Bank for International Settlements (ed.), Investigating the relationship between the financial and real economy, volume 22, pages 146-65 Bank for International Settlements.
  • Handle: RePEc:bis:bisbpc:22-09
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    References listed on IDEAS

    as
    1. Christopher J. Erceg & Andrew T. Levin, 2002. "Optimal monetary policy with durable and non-durable goods," International Finance Discussion Papers 748, Board of Governors of the Federal Reserve System (U.S.).
    2. Roberto Rigobon & Brian Sack, 2003. "Measuring The Reaction of Monetary Policy to the Stock Market," The Quarterly Journal of Economics, Oxford University Press, vol. 118(2), pages 639-669.
    3. Andrew Levin & Eric Swanson, 2004. "Optimal Monetary Policy in an Imperfect World," Computing in Economics and Finance 2004 235, Society for Computational Economics.
    4. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Solving dynamic general equilibrium models using a second-order approximation to the policy function," Journal of Economic Dynamics and Control, Elsevier, vol. 28(4), pages 755-775, January.
    5. DETKEN Carsten & SMETS Frank, "undated". "Asset Price Booms and Monetary Policy," EcoMod2003 330700042, EcoMod.
    6. Jinill Kim & Sunghyun Henry Kim & Ernst Schaumburg & Christopher A. Sims, 2003. "Calculating and using second order accurate solutions of discrete time dynamic equilibrium models," Finance and Economics Discussion Series 2003-61, Board of Governors of the Federal Reserve System (U.S.).
    7. 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.
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    Cited by:

    1. F Alexandre & P Bacao, 2006. "Investment and Non-fundamental Movements in Asset Prices: is there a role for monetary policy?," Economic Issues Journal Articles, Economic Issues, vol. 11(1), pages 65-95, March.

    More about this item

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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