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

Author

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  • DURRE, Alain

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

Abstract

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.

Suggested Citation

  • DURRE, Alain, 2001. "Would it Be Optimal for Central Banks to Include Asset Prices in Their Loss Function ?," Discussion Papers (IRES - Institut de Recherches Economiques et Sociales) 2001013, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES).
  • Handle: RePEc:ctl:louvir:2001013
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    File URL: http://sites.uclouvain.be/econ/DP/IRES/2001-13.pdf
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    Cited by:

    1. Dai, Meixing & Sidiropoulos, Moïse, 2002. "Règle du taux d'intérêt optimale, prix des actions et taux d'inflation anticipé : une étude de la stabilité macroéconomique
      [Optimal interest rate rule, asset prices and expected inflation rate : a
      ," MPRA Paper 14401, University Library of Munich, Germany, revised Jun 2003.
    2. Romaniuk, Katarzyna, 2006. "What if the Fed increased the weight of the stock price gap in its reaction function?," Journal of Policy Modeling, Elsevier, vol. 28(7), pages 725-737, October.

    More about this item

    Keywords

    Monetary Policy Objectives; Financial Asset Prices Targeting; Nominal Interest Rate;

    JEL classification:

    • E10 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - General
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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