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Monetary Policy and Stock-Price Dynamics in a DSGE Framework

  • Salvatore Nisticò

    (Università degli Studi di Roma “La Sapienza" and LUISS Guido Carli)

This paper analyzes the role of stock prices in driving Monetary Policy for price stability in a Non-Ricardian DSGE model. It shows that the dynamics of the interest rate consistent with price stability requires a response to stock-price changes that depends on the shock driving them: a supply shock (e.g. productivity) does not require an additional, dedicated response relative to the standard Representative-Agent framework, while a demand shock does. Moreover, we show that implementing the exible-price allocation by means of an interest-rate rule that reacts to deviations of the stock-price level from the exible-price equilibrium incurs risks of endogenous instability that are the higher the less profitable on average equity shares. On the other hand, reacting to the stock-price growth rate is risk-free from the perspective of equilibrium determinacy, and can be beneficial from an overall real stability perspective.

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Paper provided by Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy in its series CSEF Working Papers with number 307.

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Date of creation: 10 Feb 2012
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Handle: RePEc:sef:csefwp:307
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