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

  • Raf Wouters
  • Frank Smets

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

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Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2004 with number 132.

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Date of creation: 11 Aug 2004
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Handle: RePEc:sce:scecf4:132
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  1. 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.
  2. Stephanie Schmitt-Grohe & Martin Uribe, 2002. "Solving Dynamic General Equilibrium Models Using a Second-Order Approximation to the Policy Function," NBER Technical Working Papers 0282, National Bureau of Economic Research, Inc.
  3. Jinill Kim & Sunghyun Kim & Ernst Schaumburg & Christopher A. Sims, 2003. "Calculating and using second order accurate solutions of discrete time dynamic equilibrium models," Finance and Economics Discussion Series 2003-61, Board of Governors of the Federal Reserve System (U.S.).
  4. Roberto Rigobon & Brian Sack, 2003. "Measuring The Reaction Of Monetary Policy To The Stock Market," The Quarterly Journal of Economics, MIT Press, vol. 118(2), pages 639-669, May.
  5. Erceg, Christopher J. & Levin, Andrew T., 2002. "Optimal monetary policy with durable and non-durable goods," Working Paper Series 0179, European Central Bank.
  6. Detken, Carsten & Smets, Frank, 2004. "Asset price booms and monetary policy," Working Paper Series 0364, European Central Bank.
  7. Andrew Levin & Eric Swanson, 2004. "Optimal Monetary Policy in an Imperfect World," Computing in Economics and Finance 2004 235, Society for Computational Economics.
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