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Monetary policy and asset prices: To respond or not?

  • Q. Farook Akram

    (Norges Bank (Central Bank of Norway))

  • Gunnar Bårdsen

    (Norges Bank (Central Bank of Norway))

  • Øyvind Eitrheim

    (Norges Bank (Central Bank of Norway))

We investigate whether there is a case for asset prices in interest rates rules within a small econometric model of the Norwegian economy, modeling the interdependence of the real economy, credit and three classes of assets prices: housing prices, equity prices and the nominal exchange rate. We compare the performance of simple and efficient interest rate rules that allow for response to movements in asset prices to the performance of more standard monetary policy rules. We find that including housing prices and equity prices in the policy rules can improve macroeconomic performance in terms of both nominal and real economic stability. In contrast, a response to nominal exchange rate fluctuations can induce excess volatility in general and prove detrimental to macroeconomic stability.

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Paper provided by Norges Bank in its series Working Paper with number 2005/9.

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Length: 28 pages
Date of creation: 03 Oct 2005
Date of revision:
Handle: RePEc:bno:worpap:2005_09
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  1. Philip Lowe & Claudio Borio, 2002. "Asset prices, financial and monetary stability: exploring the nexus," BIS Working Papers 114, Bank for International Settlements.
  2. Gunnar Bårdsen, 2005. "Stylized dynamic model representations - a note," Working Paper Series 6305, Department of Economics, Norwegian University of Science and Technology.
  3. Cecchetti, Stephen G. & Kashyap, Anil K, 1996. "International cycles," European Economic Review, Elsevier, vol. 40(2), pages 331-360, February.
  4. Gunnar Bardsen & Eilev S. Jansen & Ragnar Nymoen, 2003. "Econometric inflation targeting," Econometrics Journal, Royal Economic Society, vol. 6(2), pages 430-461, December.
  5. Svensson, L.E.O., 1998. "Open-Economy Inflation Targeting," Papers 638, Stockholm - International Economic Studies.
  6. 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.
  7. Charles Bean, 2003. "Asset prices, financial imbalances and monetary policy: are inflation targets enough?," BIS Working Papers 140, Bank for International Settlements.
  8. Nicoletta Batini & Andrew G Haldane, 1999. "Forward-looking rules for monetary policy," Bank of England working papers 91, Bank of England.
  9. Carl Walsh, 2003. "Speed Limit Policies: The Output Gap and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 93(1), pages 265-278, March.
  10. Rudebusch, Glenn D, 2005. "Assessing the Lucas Critique in Monetary Policy Models," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(2), pages 245-72, April.
  11. Jagjit S. Chadha & Lucio Sarno & Giorgio Valente, 2004. "Monetary Policy Rules, Asset Prices, and Exchange Rates," IMF Staff Papers, Palgrave Macmillan, vol. 51(3), pages 529-552, November.
  12. Orphanides, Athanasios, 1999. "The Quest for Prosperity Without Inflation," Working Paper Series 93, Sveriges Riksbank (Central Bank of Sweden).
  13. Mojon, Benoît & Kashyap, Anil K. & Angeloni, Ignazio & Terlizzese, Daniele, 2002. "Monetary Transmission in the Euro Area : Where Do We Stand?," Working Paper Series 0114, European Central Bank.
  14. Gunnar Bardsen & Eilev S. Jansen & Ragnar Nymoen, 2004. "Econometric Evaluation of the New Keynesian Phillips Curve," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 66(s1), pages 671-686, 09.
  15. Angeloni, Ignazio & Ehrmann, Michael, 2003. "Monetary policy transmission in the euro area: any changes after EMU?," Working Paper Series 0240, European Central Bank.
  16. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
  17. Bardsen, Gunnar & Eitrheim, Oyvind & Jansen, Eilev S. & Nymoen, Ragnar, 2005. "The Econometrics of Macroeconomic Modelling," OUP Catalogue, Oxford University Press, number 9780199246502, March.
  18. Akram, Q. Farooq, 2006. "PPP in the medium run: The case of Norway," Journal of Macroeconomics, Elsevier, vol. 28(4), pages 700-719, December.
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