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ASSET PRICE MISALIGNMENTS AND MONETARY POLICY
Author(s) -
Bask Mikael
Publication year - 2012
Publication title -
international journal of finance and economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.505
H-Index - 39
eISSN - 1099-1158
pISSN - 1076-9307
DOI - 10.1002/ijfe.450
Subject(s) - economics , monetary policy , stock (firearms) , new keynesian economics , inflation targeting , monetary economics , rational expectations , interest rate , macroeconomics , mechanical engineering , engineering
We augment the standard New Keynesian Model for monetary policy design with stock prices in the economy and stock traders who use a mix of fundamental and technical analyses. In contrast with most of previous literature, we argue that the central bank should augment the interest rate rule with a term for stock price misalignments because a determinate and stable rational expectations equilibrium in the economy are then easier to achieve. This equilibrium is stable under least squares learning as well. Another finding is that inertia in monetary policy does not promote macroeconomic stability when technical analysis plays a major role in stock trading. Even worse, if the central bank in its policy only indirectly responds to stock price misalignments via its effect on the inflation rate, a combination of strong inertia in monetary policy and a significant role for technical analysis in stock trading will lead to macroeconomic instability. Copyright © 2011 John Wiley & Sons, Ltd.