Monetary Policy and Stock Market Boom-Bust Cycles

99 Pages Posted: 20 Nov 2008  

Lawrence J. Christiano

Northwestern University; Federal Reserve Bank of Cleveland; Federal Reserve Bank of Chicago; Federal Reserve Bank of Minneapolis; National Bureau of Economic Research (NBER)

Cosmin L. Ilut

Duke University

Roberto Motto

European Central Bank (ECB)

Massimo Rostagno

European Central Bank (ECB)

Date Written: October 31, 2008

Abstract

We explore the dynamic effects of news about a future technology improvement which turns out ex post to be overoptimistic. We find that it is difficult to generate a boom-bust cycle (a period in which stock prices, consumption, investment and employment all rise and then crash) in response to such a news shock, in a standard real business cycle model. However, a monetized version of the model which stresses sticky wages and a Taylor-rule based monetary policy naturally generates a welfare-reducing boom-bust cycle in response to a news shock. We explore the possibility that integrating credit growth into monetary policy may result in improved performance. We discuss the robustness of our analysis to alternative specifications of the labor market, in which wage-setting frictions do not distort on going firm/worker relations.

Keywords: DSGE Models, Monetary Policy, Asset price boom-busts

JEL Classification: C11, C51, E5, E13, E32

Suggested Citation

Christiano, Lawrence J. and Ilut, Cosmin L. and Motto, Roberto and Rostagno, Massimo, Monetary Policy and Stock Market Boom-Bust Cycles (October 31, 2008). ECB Working Paper No. 955. Available at SSRN: https://ssrn.com/abstract=1285421

Lawrence J. Christiano (Contact Author)

Northwestern University ( email )

2003 Sheridan Road
Evanston, IL 60208
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Federal Reserve Bank of Cleveland

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Federal Reserve Bank of Chicago

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Federal Reserve Bank of Minneapolis

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National Bureau of Economic Research (NBER)

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Cosmin L. Ilut

Duke University ( email )

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United States

HOME PAGE: http://econ.duke.edu/~cli2/index.html

Roberto Motto

European Central Bank (ECB) ( email )

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D-60311 Frankfurt am Main
Germany

Massimo Rostagno

European Central Bank (ECB) ( email )

Kaiserstrasse 29
Postfach 16 03 19
D-60311 Frankfurt am Main
Germany
+49 69 1344 7663 (Phone)
+49 69 1344 7604 (Fax)

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