Asset Price and Monetary Policy - The Effect of Expectation Formation
This paper is a theoretical study of the effects of monetary policy reacting to fluctuations in asset price, accounting for the expectation formation effect of policy regime shift in a DSGE model calibrated to the U.S. economy. We find that the effect of expectation formation can substantially influence the movement of asset price. In contrast to the linear policy rule, under the regime switching policy rule reacting to asset price can generate substantial stabilization effect: the "expected" inflation-output volatility frontier shifts downward, thereby lowering both the volatilities of inflation and output for all possible policy choices. The trade-off between the expected volatility of inflation and that of output, as demonstrated by the "Taylor curve," greatly diminishes, implying that the Taylor rule which considers expectation formation effect and asset price movement expands the set of monetary policy choices available for monetary authority.
|Date of creation:||Jan 2011|
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- Assenmacher-Wesche, Katrin & Gerlach, Stefan, 2008.
"Ensuring financial stability: Financial structure and the impact of monetary policy on asset prices,"
IMFS Working Paper Series
16, Goethe University Frankfurt, Institute for Monetary and Financial Stability (IMFS).
- Assenmacher-Wesche, Katrin & Gerlach, Stefan, 2008. "Ensuring Financial Stability: Financial Structure and the Impact of Monetary Policy on Asset Prices," CEPR Discussion Papers 6773, C.E.P.R. Discussion Papers.
- Katrin Assenmacher-Wesche & Stefan Gerlach, 2008. "Ensuring financial stability: financial structure and the impact of monetary policy on asset prices," IEW - Working Papers 361, Institute for Empirical Research in Economics - University of Zurich.
- Henrik Jensen, 2002. "Targeting Nominal Income Growth or Inflation?," American Economic Review, American Economic Association, vol. 92(4), pages 928-956, September.
- Henrik Jensen, "undated". "Targeting Nominal Income Growth or Inflation?," EPRU Working Paper Series 99-23, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics.
- Jensen, Henrik, 1999. "Targeting Nominal Income Growth or Inflation?," CEPR Discussion Papers 2341, C.E.P.R. Discussion Papers.
- Antonello D'Agostino & Luca Sala & Paolo Surico, 2005. "The Fed and the Stock Market," Macroeconomics 0507001, EconWPA.
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