48 Pages Posted: 1 Oct 2010 Last revised: 6 Aug 2014
Date Written: September 24, 2010
Historical data and model simulations support the following conclusion. Inflation is low during stock market booms, so that an interest rate rule that is too narrowly focused on inflation destabilizes asset markets and the broader economy. Adjustments to the interest rate rule can remove this source of welfare-reducing instability. For example, allowing an independent role for credit growth (beyond its role in constructing the inflation forecast) would reduce the volatility of output and asset prices.
Keywords: Inflation Targeting, Sticky Prices, Sticky Wages, Stock Price Boom, DSGE Model, New Keynesian Model, News, Interest Rate Rule
JEL Classification: E42, E58
Suggested Citation: Suggested Citation
Christiano, Lawrence J. and Ilut, Cosmin L. and Motto, Roberto and Rostagno, Massimo, Monetary Policy and Stock Market Booms (September 24, 2010). Economic Research Initiatives at Duke (ERID) Working Paper No. 69. Available at SSRN: https://ssrn.com/abstract=1684785