Should monetary policy respond to asset price misalignments

A Kontonikas, Christos Ioannidis

Research output: Contribution to journalArticle

Abstract

This paper analyses the relationship between monetary policy and asset prices using a structural rational expectations open economy model that allows for the effect of asset prices and exchange rates on aggregate demand. We assume that asset prices and exchange rates 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.
Original languageEnglish
Pages (from-to)1105-1121
Number of pages17
JournalEconomic Modelling
Volume22
Issue number6
DOIs
Publication statusPublished - 2005

Bibliographical note

© 2005, Elsevier. Licensed under the Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International http://creativecommons.org/licenses/by-nc-nd/4.0/

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