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Monetary Policy, Doubts and Asset Prices

  • Pierpaolo Benigno
  • Luigi Paciello

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 the nature of the policy that maximizes the welfare of the consumers in the model. First, following productivity shocks, optimal policy in this model is more accommodating than in a standard New-Keynesian model, and may even 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 may result in lower average welfare than a more flexible inflation-targeting policy, which instead increases the comovements between inflation, asset prices and output growth.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16386.

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Date of creation: Sep 2010
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Handle: RePEc:nbr:nberwo:16386
Note: EFG ME
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