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Would it Be Optimal for Central Banks to Include Asset Prices in Their Loss Function ?

Listed author(s):
  • DURRE, Alain

    (UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES))

This paper has three purposes. First, we discuss under which conditions a Central Bank should include financial asset prices in its objectives’function and how this affects the optimal monetary policy in a rational expectations forward-looking model. Second, we show that the volatility of the policy instrument (i.e. nominal interest rate) is modified compared to the case where financial asset prices do not appear in the monetary policy loss function. We find that the volatility of nominal interest rate is lower in the first case when the economy faces demand shocks contrary to supply and financial shocks. In both cases, the reaction of monetary policy instruments to several shocks in the economy is depending on the sensibility of aggregate demand to real stock prices. Third, we show that the shape of the nominal-interest rate response to shocks depends on the weights given to inflation targeting and financial stability’s goal.

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Paper provided by Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES) in its series Discussion Papers (IRES - Institut de Recherches Economiques et Sociales) with number 2001013.

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Length: 26
Date of creation: 01 Jun 2001
Handle: RePEc:ctl:louvir:2001013
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