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OPTIMAL MONETARY POLICY AND ASSET PRICE MISALIGNMENTS
Author(s) -
Kontonikas Alexandros,
Montagnoli Alberto
Publication year - 2006
Publication title -
scottish journal of political economy
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.4
H-Index - 46
eISSN - 1467-9485
pISSN - 0036-9292
DOI - 10.1111/j.1467-9485.2006.00398.x
Subject(s) - economics , asset (computer security) , monetary policy , volatility (finance) , inflation (cosmology) , monetary economics , rational expectations , context (archaeology) , output gap , microeconomics , capital asset pricing model , interest rate , consumption based capital asset pricing model , econometrics , value (mathematics) , financial economics , paleontology , physics , computer security , machine learning , theoretical physics , computer science , biology
This paper analyses the relationship between monetary policy and asset prices in the context of optimal policy rules. The transmission mechanism is represented by a linearized rational expectations model augmented for the effect of asset prices on aggregate demand. Stabilization objectives are represented by a discounted quadratic loss function penalizing inflation and output gap volatility. Asset prices are allowed to deviate from their intrinsic value due to momentum trading. We find that in the presence of wealth effects and inefficient markets, asset price misalignments from their fundamentals should be included in the optimal interest rate reaction function.