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Monetary policy, asset prices and model uncertainty

Author

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  • Meixing DAI
  • Eleftherios SPYROMITROS

Abstract

Using a macroeconomic model with asset prices, we analyze how optimal monetary policy, and macroeconomic dynamics and performance are affected by the central bank’s desire to be robust against model misspecifications. Considering the worst-case model, we show that an increase in the central bank’s preference for robustness requires a more aggressive reaction of the optimal nominal interest rate with respect to expected inflation and inflation shocks. According to the value of structural parameters, the economic equilibrium can be stable or saddle-point stable. In both cases, the speed of dynamic convergence is smaller under robust control compared to a benchmark case without it. Finally, an increase in the preference for robustness reinforces the reaction of current and expected future inflation, asset prices and output-gap to inflation shocks. However, the preference for robustness has no effect on the reaction of asset prices to the shocks affecting goods demand and financial markets.

Suggested Citation

  • Meixing DAI & Eleftherios SPYROMITROS, 2008. "Monetary policy, asset prices and model uncertainty," Working Papers of BETA 2008-15, Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg.
  • Handle: RePEc:ulp:sbbeta:2008-15
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    More about this item

    Keywords

    Monetary policy; asset prices; model uncertainty; macro-financial stability.;

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • 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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