IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Log in (now much improved!) to save this paper

Should Monetary Policy Respond to Asset Price Misalignments?

Listed author(s):
  • Alexandros Kontonikas

    (Brunel University)

  • Christos Ioannidis

    (Brunel University)

This paper analyses the relationship between monetary policy and asset prices using a structural rational expectations model that allows for the effect of asset prices on aggregate demand. We assume that asset prices follow a partial adjustment mechanism whereas they are positively affected by past changes, thus allowing for ‘momentum trading’, while at the same time we allow for reversion towards fundamentals. We then conduct stochastic simulations using two alternative monetary policy rules, inflation-forecast targeting and the standard Taylor rule. The results indicate that, under both rules, interest rate setting that takes into account asset price misalignments leads to lower overall macroeconomic volatility, as measured by the postulated loss function of the central bank.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://econwpa.repec.org/eps/mac/papers/0404/0404026.pdf
Download Restriction: no

Paper provided by EconWPA in its series Macroeconomics with number 0404026.

as
in new window

Length: 24 pages
Date of creation: 26 Apr 2004
Handle: RePEc:wpa:wuwpma:0404026
Note: Type of Document - pdf; pages: 24
Contact details of provider: Web page: http://econwpa.repec.org

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as
in new window


  1. Fama, Eugene F, 1981. "Stock Returns, Real Activity, Inflation, and Money," American Economic Review, American Economic Association, vol. 71(4), pages 545-565, September.
  2. A. Kontonikas & A. Montagnoli, 2002. "Has Monetary Policy Reacted To Asset Price Movements: Evidence From The Uk," Economics and Finance Discussion Papers 02-11, Economics and Finance Section, School of Social Sciences, Brunel University.
  3. Laurence Ball, 1998. "Policy Rules for Open Economies," RBA Research Discussion Papers rdp9806, Reserve Bank of Australia.
  4. Orphanides, Athanasios & Porter, Richard D. & Reifschneider, David & Tetlow, Robert & Finan, Frederico, 2000. "Errors in the measurement of the output gap and the design of monetary policy," Journal of Economics and Business, Elsevier, vol. 52(1-2), pages 117-141.
  5. Kiyotaki, Nobuhiro & Moore, John, 1997. "Credit Cycles," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 211-248, April.
  6. Stephen G. Cecchetti & Anil K Kashyap, 1995. "International Cycles," NBER Working Papers 5310, National Bureau of Economic Research, Inc.
  7. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
  8. Glenn D. Rudebusch & Lars E. O. Svensson, 1998. "Policy rules for inflation targeting," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  9. Ben S. Bernanke & Mark Gertler, 2001. "Should Central Banks Respond to Movements in Asset Prices?," American Economic Review, American Economic Association, vol. 91(2), pages 253-257, May.
  10. Detken, Carsten & Smets, Frank, 2004. "Asset price booms and monetary policy," Working Paper Series 0364, European Central Bank.
  11. Canova, Fabio & Nicol , Gianni De, 2000. "Stock Returns, Term Structure, Inflation, And Real Activity: An International Perspective," Macroeconomic Dynamics, Cambridge University Press, vol. 4(03), pages 343-372, September.
  12. Bennett T. McCallum & Edward Nelson, 1997. "An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis," NBER Working Papers 5875, National Bureau of Economic Research, Inc.
  13. Garber, Peter M, 1990. "Famous First Bubbles," Journal of Economic Perspectives, American Economic Association, vol. 4(2), pages 35-54, Spring.
  14. McCallum, Bennett T., 1998. "Solutions to linear rational expectations models: a compact exposition," Economics Letters, Elsevier, vol. 61(2), pages 143-147, November.
  15. Bennett T. McCallum, 2001. "Should Monetary Policy Respond Strongly to Output Gaps?," NBER Working Papers 8226, National Bureau of Economic Research, Inc.
  16. Bordo, Michael D & Jeanne, Olivier, 2002. "Boom-Busts in Asset Prices, Economic Instability and Monetary Policy," CEPR Discussion Papers 3398, C.E.P.R. Discussion Papers.
  17. Michael Woodford, 1999. "Optimal Monetary Policy Inertia," NBER Working Papers 7261, National Bureau of Economic Research, Inc.
  18. Ben S. Bernanke & Mark Gertler, 1999. "Monetary policy and asset price volatility," Economic Review, Federal Reserve Bank of Kansas City, issue Q IV, pages 17-51.
  19. Thorbecke, Willem, 1997. " On Stock Market Returns and Monetary Policy," Journal of Finance, American Finance Association, vol. 52(2), pages 635-654, June.
  20. Batini, Nicoletta & Nelson, Edward, 2000. "When the Bubble Bursts: Monetary Policy Rules and Foreign Exchange Market Behavior," Working Papers 2000-01, University of Sydney, School of Economics.
  21. Gilchrist, Simon & Leahy, John V., 2002. "Monetary policy and asset prices," Journal of Monetary Economics, Elsevier, vol. 49(1), pages 75-97, January.
  22. Klein, Paul, 2000. "Using the generalized Schur form to solve a multivariate linear rational expectations model," Journal of Economic Dynamics and Control, Elsevier, vol. 24(10), pages 1405-1423, September.
  23. Tro Kortian, 1995. "Modern Approaches to Asset Price Formation: A Survey of Recent Theoretical Literature," RBA Research Discussion Papers rdp9501, Reserve Bank of Australia.
  24. Nicoletta Batini & Andrew G Haldane, 1999. "Forward-looking rules for monetary policy," Bank of England working papers 91, Bank of England.
  25. Conover, C. Mitchell & Jensen, Gerald R. & Johnson, Robert R., 1999. "Monetary environments and international stock returns," Journal of Banking & Finance, Elsevier, vol. 23(9), pages 1357-1381, September.
  26. Narayana R. Kocherlakota, 2000. "Creating business cycles through credit constraints," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum, pages 2-10.
  27. Goodhart, Charles & Hofmann, Boris, 2000. "Financial Variables and the Conduct of Monetary Policy," Working Paper Series 112, Sveriges Riksbank (Central Bank of Sweden).
  28. Charles A. E. Goodhart & Boris Hofmann, 2001. "Asset prices, financial conditions and the transmission of monetary policy," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  29. Charles Goodhart & Boris Hofmann, 2003. "Deflation, Credit and Asset Prices," Working Papers 132003, Hong Kong Institute for Monetary Research.
  30. Philip Lowe & Claudio Borio, 2002. "Asset prices, financial and monetary stability: exploring the nexus," BIS Working Papers 114, Bank for International Settlements.
  31. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:wpa:wuwpma:0404026. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (EconWPA)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.