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Welfare analysis of non-fundamental asset price and investment shocks: Implications for monetary policy

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  • Raf Wouters
  • Frank Smets

Abstract

Using a sticky price-wage model with capital accumulation and adjustment costs, this paper analyses the welfare effects of non-fundamental asset price and investment fluctuations for the representative household. The welfare effect depends strongly on the steady state level around which the economy is fluctuating. If output is below the first best competitive equilibirum because of the existence of markups in a monopolisitc competitive environment, asset price booms and the resulting positive investment and demand effects move the economy in the direction of the efficient output and can therefore be welfare improving. In such a case, optimal monetary policy will no longer be characterised by a symmetric response to inflation and output movements around the steady state, but will typically need to adjust asymmetrically

Suggested Citation

  • Raf Wouters & Frank Smets, 2004. "Welfare analysis of non-fundamental asset price and investment shocks: Implications for monetary policy," Computing in Economics and Finance 2004 132, Society for Computational Economics.
  • Handle: RePEc:sce:scecf4:132
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    References listed on IDEAS

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    1. Christopher J. Erceg & Andrew T. Levin, 2002. "Optimal monetary policy with durable and non-durable goods," International Finance Discussion Papers 748, Board of Governors of the Federal Reserve System (U.S.).
    2. Andrew Levin & Eric Swanson, 2004. "Optimal Monetary Policy in an Imperfect World," Computing in Economics and Finance 2004 235, Society for Computational Economics.
    3. DETKEN Carsten & SMETS Frank, "undated". "Asset Price Booms and Monetary Policy," EcoMod2003 330700042, EcoMod.
    4. Christopher A. Sims & Jinill Kim & Sunghyun Kim, 2003. "Calculating and Using Second Order Accurate Solution of Discrete Time Dynamic Equilibrium Models," Computing in Economics and Finance 2003 162, Society for Computational Economics.
    5. 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.
    6. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Solving dynamic general equilibrium models using a second-order approximation to the policy function," Journal of Economic Dynamics and Control, Elsevier, vol. 28(4), pages 755-775, January.
    7. Roberto Rigobon & Brian Sack, 2003. "Measuring The Reaction of Monetary Policy to the Stock Market," The Quarterly Journal of Economics, Oxford University Press, vol. 118(2), pages 639-669.
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    Cited by:

    1. 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.

    More about this item

    Keywords

    DSGE models; Welfare; Monetary Policy;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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