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Monetary policy and asset prices: To respond or not?

  • Gunnar Bårdsen


    (Bank of Norway and Department of Economics, Norwegian University of Science and Technology)

  • Q. Farooq Akram

    (Bank of Norway)

  • Øyvind Eitrheim


    (Bank of Norway)

We investigate whether there is a case for asset prices in interest rates rules within a small econometric model of the Norwegian economy, modeling the interdependence of the real economy, credit and three classes of assets prices: housing prices, equity prices and the nominal exchange rate. We compare the performance of simple and efficient interest rate rules that allow for response to movements in asset prices to the performance of more standard monetary policy rules. We find that including housing prices and equity prices in the policy rules can improve macroeconomic performance in terms of both nominal and real economic stability. In contrast, a response to nominal exchange rate fluctuations can induce excess volatility in general and prove detrimental to macroeconomic stability.

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Paper provided by Department of Economics, Norwegian University of Science and Technology in its series Working Paper Series with number 5405.

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Length: 26 pages
Date of creation: 15 Sep 2005
Date of revision:
Handle: RePEc:nst:samfok:5405
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  1. Bardsen, Gunnar & Eitrheim, Oyvind & Jansen, Eilev S. & Nymoen, Ragnar, 2005. "The Econometrics of Macroeconomic Modelling," OUP Catalogue, Oxford University Press, number 9780199246502, December.
  2. Gunnar Bardsen & Eilev S. Jansen & Ragnar Nymoen, 2003. "Econometric inflation targeting," Econometrics Journal, Royal Economic Society, vol. 6(2), pages 430-461, December.
  3. Andrew G. Haldane & Nicoletta Batini, 1998. "Forward-Looking Rules for Monetary Policy," NBER Working Papers 6543, National Bureau of Economic Research, Inc.
  4. Jagjit S. Chadha & Lucio Sarno & Giorgio Valente, 2004. "Monetary Policy Rules, Asset Prices and Exchange Rates," CDMA Working Paper Series 200403, Centre for Dynamic Macroeconomic Analysis.
  5. Glenn D. Rudebusch, 2002. "Assessing the Lucas critique in monetary policy models," Working Paper Series 2002-02, Federal Reserve Bank of San Francisco.
  6. Angeloni, Ignazio & Ehrmann, Michael, 2003. "Monetary policy transmission in the euro area: any changes after EMU?," Working Paper Series 0240, European Central Bank.
  7. Stephen G. Cecchetti & Anil K Kashyap, 1995. "International Cycles," NBER Working Papers 5310, National Bureau of Economic Research, Inc.
  8. Michael D. Bordo & Olivier Jeanne, 2002. "Boom-Busts in Asset Prices, Economic Instability, and Monetary Policy," NBER Working Papers 8966, National Bureau of Economic Research, Inc.
  9. Svensson, Lars E. O., 2000. "Open-economy inflation targeting," Journal of International Economics, Elsevier, vol. 50(1), pages 155-183, February.
  10. Charles Bean, 2003. "Asset prices, financial imbalances and monetary policy: are inflation targets enough?," BIS Working Papers 140, Bank for International Settlements.
  11. Carl Walsh, 2001. "Speed Limit Policies: The Output Gap and Optimal Monetary Policy," CESifo Working Paper Series 609, CESifo Group Munich.
  12. Akram, Q. Farooq, 2006. "PPP in the medium run: The case of Norway," Journal of Macroeconomics, Elsevier, vol. 28(4), pages 700-719, December.
  13. Mojon, Benoît & Kashyap, Anil K. & Angeloni, Ignazio & Terlizzese, Daniele, 2002. "Monetary Transmission in the Euro Area : Where Do We Stand?," Working Paper Series 0114, European Central Bank.
  14. 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.
  15. Philip Lowe & Claudio Borio, 2002. "Asset prices, financial and monetary stability: exploring the nexus," BIS Working Papers 114, Bank for International Settlements.
  16. Orphanides, Athanasios, 2003. "The quest for prosperity without inflation," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 633-663, April.
  17. Gunnar Bardsen & Eilev S. Jansen & Ragnar Nymoen, 2004. "Econometric Evaluation of the New Keynesian Phillips Curve," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 66(s1), pages 671-686, 09.
  18. Gunnar Bårdsen, 2005. "Stylized dynamic model representations - a note," Working Paper Series 6305, Department of Economics, Norwegian University of Science and Technology.
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