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Monetary Policy, Stock Price Misalignments and Macroeconomic Instability

  • Bask, Mikael

    ()

    (Hanken School of Economics)

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.

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File URL: http://dhanken.shh.fi/dspace/bitstream/10227/369/1/540-978-952-232-036-0.pdf
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Paper provided by Hanken School of Economics in its series Working Papers with number 540.

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Length: 27 pages
Date of creation: 05 Jun 2009
Date of revision:
Handle: RePEc:hhb:hanken:0540
Contact details of provider: Postal:
Hanken School of Economics, Arkadiankatu 22, P.O.B. 479; FIN 00101 Helsinki, Finland

Phone: +358-9-431 331
Fax: +358-9-431 33 333
Web page: http://www.hanken.fi

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  3. Alexandros Kontonikas & Christos Ioannidis, 2003. "Should Monetary Policy Respond to Asset Price Misalignments?," Economics and Finance Discussion Papers 03-19, Economics and Finance Section, School of Social Sciences, Brunel University.
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  9. Menkhoff, Lukas & Taylor, Mark P., 2006. "The Obstinate Passion of Foreign Exchange Professionals: Technical Analysis," Hannover Economic Papers (HEP) dp-352, Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät.
  10. Charles R. Bean, 2004. "Asset Prices, Financial Instability, and Monetary Policy," American Economic Review, American Economic Association, vol. 94(2), pages 14-18, May.
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  16. Alexandros Kontonikas & Alberto Montagnoli, 2005. "Optimal Monetary Policy and Asset Price Misalignments," Working Papers 2005_9, Business School - Economics, University of Glasgow.
  17. Mikael Bask & Carina Selander, 2009. "Robust Taylor rules under heterogeneity in currency trade," International Economics and Economic Policy, Springer, vol. 6(3), pages 283-313, October.
  18. Glenn D. Rudebusch, 2005. "Monetary policy and asset price bubbles," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue aug5.
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  22. Marcet, Albert & Sargent, Thomas J., 1989. "Convergence of least squares learning mechanisms in self-referential linear stochastic models," Journal of Economic Theory, Elsevier, vol. 48(2), pages 337-368, August.
  23. 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.
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  28. Goodhart, Charles & Hofmann, Boris, 2000. "Financial Variables and the Conduct of Monetary Policy," Working Paper Series 112, Sveriges Riksbank (Central Bank of Sweden).
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