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Fundamental Paper Wealth and Monetary Policy

Author

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  • Junning Cai

    (University of Hawaii at Manoa)

Abstract

This paper articulates three insights regarding asset prices and monetary policy: (1) Asset price appreciation due to monetary expansion, despite its “paper” wealth nature, tends to make current consumers as a whole wealthier; (2) the wealth effect of monetary policy (on consumption) is negatively correlated with Tobin’s q effect (on investment), which positively depends on investment elasticity; and (3) the soundness of asset market performances does not depend on whether they are fundamental or not, but on their compatibility with the AD-AS balance in the long run. These basic insights and their implications reveal some limitations of monetary policy as a stabilization policy, clarify some misperceptions on fundamental asset prices, and provide a rationale for monetary policy to react directly to asset market performances.

Suggested Citation

  • Junning Cai, 2003. "Fundamental Paper Wealth and Monetary Policy," Macroeconomics 0309001, EconWPA.
  • Handle: RePEc:wpa:wuwpma:0309001
    Note: Type of Document - pdf; prepared on pc; to print on HP/PostScript/Franciscan monk; pages: 46; figures: included
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    File URL: http://econwpa.repec.org/eps/mac/papers/0309/0309001.pdf
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    References listed on IDEAS

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    3. Norman Loayza & Klaus Schmidt-Hebbel, 2002. "Monetary Policy Functions and Transmission Mechanisms: An Overview," Central Banking, Analysis, and Economic Policies Book Series,in: Norman Loayza & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series (ed.), Monetary Policy: Rules and Transmission Mechanisms, edition 1, volume 4, chapter 1, pages 001-020 Central Bank of Chile.
    4. Tobin, James, 1969. "A General Equilibrium Approach to Monetary Theory," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 1(1), pages 15-29, February.
    5. Bernanke, Ben S. & Gertler, Mark & Gilchrist, Simon, 1999. "The financial accelerator in a quantitative business cycle framework," Handbook of Macroeconomics,in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 21, pages 1341-1393 Elsevier.
    6. 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.
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    8. Stephen G. Cecchetti & Hans Genberg & Sushil Wadhwani, 2002. "Asset Prices in a Flexible Inflation Targeting Framework," NBER Working Papers 8970, National Bureau of Economic Research, Inc.
    9. King, R.G., 1989. "Value And Capital - In The Equilibrium Business Cycle Program," RCER Working Papers 207, University of Rochester - Center for Economic Research (RCER).
    10. Cecchetti, Stephen G. & Kashyap, Anil K, 1996. "International cycles," European Economic Review, Elsevier, vol. 40(2), pages 331-360, February.
    11. Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, number 5474.
    12. Blanchard, Olivier J, 1985. "Debt, Deficits, and Finite Horizons," Journal of Political Economy, University of Chicago Press, vol. 93(2), pages 223-247, April.
    13. Douglas W. Elmendorf, "undated". "The Effect of Interest-Rate Changes on Household Saving and Consumption: A Survey," Finance and Economics Discussion Series 1996-27, Board of Governors of the Federal Reserve System (U.S.).
    14. Andrew B. Abel & Janice C. Eberly, "undated". "An Exact Solution for the Investment and Market Value of a Firm Facing Uncertainty, Adjustment Costs, and Irreversibility," Rodney L. White Center for Financial Research Working Papers 12-93, Wharton School Rodney L. White Center for Financial Research.
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    Cited by:

    1. Junning Cai, 2004. "Liquidity Trap Prevention and Escape: A Simple Proposition," Macroeconomics 0402033, EconWPA.
    2. Junning Cai & Byron Gangnes, 2004. "Open Capital Account: Concrete Wealth or Paper Wealth," International Finance 0401002, EconWPA.

    More about this item

    Keywords

    Fundamental Paper Wealth; Wealth Effect; Bubbles; Monetary Policy;

    JEL classification:

    • E - Macroeconomics and Monetary Economics
    • G - Financial Economics

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