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Monetary Policy, Stock Price Misalignments and Macroeconomic Instability

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  • Bask, Mikael

    () (Hanken School of Economics)

Abstract

We augment the standard New Keynesian model for monetary policy design with stock prices in the economy and stock traders wh use a mix of fundamental and technical analyses. The central question in this paper is whether macroeconomic stability can be achieved by an appropriate policy by the central ank? In contrast with most of previous literature, we argue that the central bank should augment the interest rate rule with a term for stock price misalignments since a determiate and stable rational expectations equilibrium in the economy is then easier to achieve. This equilibrium is stable under least squares learning as well. Another interesting finding is that inertia in monetary policy does not promote macroeconomic stability when technical analysis plays a major role in stock trading. Even worse, if the central bank in its policy only indirectly responds to stock price misalignments via its effect on the inflation rate, a combination of strong inertia in monetary policy and a significant role for technical analysis in stock trading will lead to macroeconomic instability.

Suggested Citation

  • Bask, Mikael, 2009. "Monetary Policy, Stock Price Misalignments and Macroeconomic Instability," Working Papers 540, Hanken School of Economics.
  • Handle: RePEc:hhb:hanken:0540
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    References listed on IDEAS

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    Cited by:

    1. Matthias Lengnick & Hans-Werner Wohltmann, 2013. "Agent-based financial markets and New Keynesian macroeconomics: a synthesis," Journal of Economic Interaction and Coordination, Springer;Society for Economic Science with Heterogeneous Interacting Agents, vol. 8(1), pages 1-32, April.

    More about this item

    Keywords

    Bubble Policy; Fundamental Analysis; Interest Rate Rule; Least Squares Learning; Macroeconomic Stability; Stock Price Bubble; Taylor Rule; Technical Analysis;

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