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Monetary Policy, Investment and Non-Fundamental Shocks

Using a sticky price model with endogenous investment and adjustment costs we analyse the benefits of monetary policy reacting to asset prices, when investment is under the influence of a non-fundamental shock, both for inflation-forecast targeting rules and for Taylor rules. We conclude that in this context there are benefits from reacting to asset prices that result from a more stable output gap, which is the consequence of a much lower volatility in firms’ investment. However, welfare gains depend on the source of asset price movements. Reacting to asset prices when there is a non-fundamental shock to investment stabilises both the asset price and inflation.

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Paper provided by NIPE - Universidade do Minho in its series NIPE Working Papers with number 6/2002.

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Date of creation: 2002
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Handle: RePEc:nip:nipewp:6/2002
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  10. Alexandre, Fernando & Driffill, John & Spagnolo, Fabio, 2002. "Inflation Targeting, Exchange Rate Volatility and International Policy Coordination," Manchester School, University of Manchester, vol. 70(4), pages 546-69, Special I.
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  20. McCallum, Bennett T & Nelson, Edward, 1999. "An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(3), pages 296-316, August.
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  22. Shiller, Robert J, 1981. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," American Economic Review, American Economic Association, vol. 71(3), pages 421-36, June.
  23. Soderlind, Paul, 1999. "Solution and estimation of RE macromodels with optimal policy," European Economic Review, Elsevier, vol. 43(4-6), pages 813-823, April.
  24. Hayashi, Fumio, 1982. "Tobin's Marginal q and Average q: A Neoclassical Interpretation," Econometrica, Econometric Society, vol. 50(1), pages 213-24, January.
  25. Robert S. Chirinko & Huntley Schaller, 2001. "Business Fixed Investment and "Bubbles": The Japanese Case," American Economic Review, American Economic Association, vol. 91(3), pages 663-680, June.
  26. Nathan S. Balke & Mark E. Wohar, 2006. "What Drives Stock Prices? Identifying the Determinants of Stock Price Movements," Southern Economic Journal, Southern Economic Association, vol. 73(1), pages 55–78, July.
  27. Jonathan Temple, 2002. "The Assessment: The New Economy," Oxford Review of Economic Policy, Oxford University Press, vol. 18(3), pages 241-264.
  28. Randall Morck & Andrei Shleifer & Robert W. Vishny, 1990. "The Stock Market and Investment: Is the Market a Sideshow?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 21(2), pages 157-216.
  29. William Poole, 2001. "What role for asset prices in U.S. monetary policy?," Speech 57, Federal Reserve Bank of St. Louis.
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