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Determinacy, Stock Market Dynamics and Monetary Policy Inertia

  • Damjan Pfajfar

    (Tilburg University)

  • Emiliano Santoro

    (Department of Economics, University of Copenhagen)

This note deals with the stability properties of an economy where the central bank is concerned with stock market developments. We introduce a Taylor rule reacting to stock price growth rates along with inflation and output gap in a New-Keynesian setup. We explore the performance of this rule from the vantage of equilibrium uniqueness. We show that this reaction function is isomorphic to a rule with an interest rate smoothing term, whose magnitude increases in the degree of aggressiveness towards asset prices growth. As shown by Bullard and Mitra (2007, Determinacy, learnability, and monetary policy inertia, Journal of Money, Credit and Banking 39, 1177-1212) this feature of monetary policy inertia can help at alleviating problems of indeterminacy.

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File URL: http://www.econ.ku.dk/english/research/publications/wp/2008/0830.pdf
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Paper provided by University of Copenhagen. Department of Economics in its series Discussion Papers with number 08-30.

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Length: 8 pages
Date of creation: Nov 2008
Date of revision:
Handle: RePEc:kud:kuiedp:0830
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  1. Kaushik Mitra & James Bullard, 2004. "Determinacy, Learnability, and Monetary Policy Inertia," Royal Holloway, University of London: Discussion Papers in Economics 04/14, Department of Economics, Royal Holloway University of London, revised Jul 2004.
  2. Julio J. Rotemberg & Michael Woodford, 1998. "Interest-Rate Rules in an Estimated Sticky Price Model," NBER Working Papers 6618, National Bureau of Economic Research, Inc.
  3. Glenn D. Rudebusch, 2006. "Monetary Policy Inertia: Fact or Fiction?," International Journal of Central Banking, International Journal of Central Banking, vol. 2(4), December.
  4. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "The science of monetary policy: A new Keynesian perspective," Economics Working Papers 356, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 1999.
  5. Pfajfar, D. & Santoro, E., 2012. "Credit Market Distortions, Asset Prices and Monetary Policy," Discussion Paper 2012-010, Tilburg University, Center for Economic Research.
  6. Giorgio Di Giorgio & Salvatore Nistico, 2007. "Monetary Policy and Stock Prices in an Open Economy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(8), pages 1947-1985, December.
  7. Ben Bernanke & Mark Gertler, 1999. "Monetary policy and asset price volatility," Economic Review, Federal Reserve Bank of Kansas City, issue Q IV, pages 17-51.
  8. Woodford, M., 1999. "Optimal Monetary Policy Inertia.," Papers 666, Stockholm - International Economic Studies.
  9. McCallum, Bennett T., 1999. "Issues in the design of monetary policy rules," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 23, pages 1483-1530 Elsevier.
  10. Julio J. Rotemberg & Michael Woodford, 1998. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy: Expanded Version," NBER Technical Working Papers 0233, National Bureau of Economic Research, Inc.
  11. Charles T. Carlstrom & Timothy S. Fuerst, 2004. "Asset prices, nominal rigidities, and monetary policy," Working Paper 0413, Federal Reserve Bank of Cleveland.
  12. Michael Woodford, 2003. "Optimal Interest-Rate Smoothing," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 861-886.
  13. Kaushik Mitra & James Bullard, . "Learning About Monetary Policy Rules," Discussion Papers 00/41, Department of Economics, University of York.
  14. Glenn D. Rudebusch, 1995. "Federal Reserve interest rate targeting, rational expectations, and the term structure," Working Papers in Applied Economic Theory 95-02, Federal Reserve Bank of San Francisco.
  15. Michael Woodford, 2001. "The Taylor Rule and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 91(2), pages 232-237, May.
  16. Ben S. Bernanke & Mark Gertler, 2001. "Should Central Banks Respond to Movements in Asset Prices?," American Economic Review, American Economic Association, vol. 91(2), pages 253-257, May.
  17. James B. Bullard & Eric Schaling, 2002. "Why the Fed should ignore the stock market," Review, Federal Reserve Bank of St. Louis, issue Mar., pages 35-42.
  18. 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.
  19. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-11, July.
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