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Monetary Policy, Doubts and Asset Prices

  • Pierpaolo Benigno

    (LUISS and EIEF)

  • Luigi Paciello

    (EIEF)

Asset prices and the equity premium might reflect doubts and pessimism. Introducing these features in an otherwise standard New-Keynesian model changes in a quite substantial way its normative conclusions. First, following productivity shocks, optimal policy should be very accommodative even to the point to inflate the equity premium. Second, asset-price movements improve the inflation-output trade-off so that average output can rise without increasing much average inflation. Finally, a strict inflation-targeting policy is dominated by more flexible inflation targeting policies which increase the comovements between inflation, asset prices and output growth.

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Paper provided by Einaudi Institute for Economics and Finance (EIEF) in its series EIEF Working Papers Series with number 1024.

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Length: 35 pages
Date of creation: 2010
Date of revision: Sep 2010
Handle: RePEc:eie:wpaper:1024
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