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Equity Prices and Monetary Policy: An Overview with an Exploratory Model

Author

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  • Pedro Bacao
  • Fernando Alexandre

Abstract

Financial stability, with an emphasis on the relevance of asset prices stability to the stability of the overall economy, has become the sub ject of wide discussion among monetary authorities. Closely related to these issues are the concerns of central bankers with a bubble economy and its aftermath. After briefly surveying the potential links between financial markets and the real economy and its implications for the design of monetary policy, we illustrate some of the issues in this literature through the analysis of a simple linear rational expectations model. From this exercise we conclude that the benefits of reacting to asset prices depend crucially on the kind of shock hitting the economy. Ideally, reacting to the misalignment of equity prices is desirable. However, the presence of uncertainty in the estimation of the variables to which the policy rule responds may overturn this conclusion.
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Suggested Citation

  • Pedro Bacao & Fernando Alexandre, 2003. "Equity Prices and Monetary Policy: An Overview with an Exploratory Model," Computing in Economics and Finance 2003 290, Society for Computational Economics.
    • Handle: RePEc:sce:scecf3:290
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    Cited by:

    1. Fernando Alexandre, 2002. "Monetary Policy, Investment and Non-Fundamental Shocks," NIPE Working Papers 6/2002, NIPE - Universidade do Minho.
    2. Luís, Pacheco, 2004. "Asset Prices and Monetary Policy in the Euro Area: a tentative model," MPRA Paper 6579, University Library of Munich, Germany.
    3. F Alexandre & P Bacao, 2006. "Investment and Non-fundamental Movements in Asset Prices: is there a role for monetary policy?," Economic Issues Journal Articles, Economic Issues, vol. 11(1), pages 65-95, March.
    4. Angelos Kanas & Christos Ioannidis, 2010. "Causality from real stock returns to real activity: evidence of regime-dependence," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 15(2), pages 180-197.

    More about this item

    Keywords

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    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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