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

Fingerprint

Misalignment
Asset prices
Monetary policy
Exchange rates
Taylor rule
Central bank
Loss function
Interest rate rules
Stochastic simulation
Aggregate demand
Open economy
Partial adjustment
Rational expectations
Monetary policy rules
Momentum trading
Inflation forecasts
Targeting
Macroeconomic volatility

Bibliographical note

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

Cite this

Kontonikas, A ; Ioannidis, Christos. / Should monetary policy respond to asset price misalignments. In: Economic Modelling. 2005 ; Vol. 22, No. 6. pp. 1105-1121.
@article{4b443ec4b6924b34b769d8995fc7352c,
title = "Should monetary policy respond to asset price misalignments",
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.",
author = "A Kontonikas and Christos Ioannidis",
note = "{\circledC} 2005, Elsevier. Licensed under the Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International http://creativecommons.org/licenses/by-nc-nd/4.0/",
year = "2005",
doi = "10.1016/j.econmod.2005.07.004",
language = "English",
volume = "22",
pages = "1105--1121",
number = "6",

}

Should monetary policy respond to asset price misalignments. / Kontonikas, A; Ioannidis, Christos.

In: Economic Modelling, Vol. 22, No. 6, 2005, p. 1105-1121.

Research output: Contribution to journalArticle

TY - JOUR

T1 - Should monetary policy respond to asset price misalignments

AU - Kontonikas, A

AU - Ioannidis, Christos

N1 - © 2005, Elsevier. Licensed under the Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International http://creativecommons.org/licenses/by-nc-nd/4.0/

PY - 2005

Y1 - 2005

N2 - 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.

AB - 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.

UR - https://www.sciencedirect.com/science/article/pii/S0264999305000623

U2 - 10.1016/j.econmod.2005.07.004

DO - 10.1016/j.econmod.2005.07.004

M3 - Article

VL - 22

SP - 1105

EP - 1121

IS - 6

ER -