Asset Prices and Optimal Monetary Policy Rules

38 Pages Posted: 16 Jul 2016 Last revised: 19 May 2017

See all articles by Venoo Kakar

Venoo Kakar

San Francisco State University

Stefano d'Addona

University of Roma Tre

Marcelle Chauvet

University of California Riverside; University of California Riverside

Date Written: May 18, 2017

Abstract

We construct a New Keynesian DSGE model that features financial frictions, investment frictions, long-run productivity risk, and Epstein and Zin (1989) preferences. The model successfully reproduces key features of both asset prices and macroeconomic quantities. Under this set up, we examine the implications of different monetary policy rules where the central bank responds to inflation, output and asset prices in the presence of productivity shocks, monetary policy shocks, and financial shocks. Our main result suggests that in the presence of these shocks, optimal monetary policy should react to asset prices over and above the inflation and output outlook in order to achieve greater macroeconomic and financial stability. This paper contributes to the current debate on how central bankers ought to respond to asset price volatility, in the context of an overall strategy for monetary policy.

Keywords: Optimal monetary policy, Asset pricing, Recursive utility, Long-run risk

JEL Classification: E37, E44, E52, E58, G12

Suggested Citation

Kakar, Venoo and d'Addona, Stefano and Chauvet, Marcelle, Asset Prices and Optimal Monetary Policy Rules (May 18, 2017). Available at SSRN: https://ssrn.com/abstract=2810256 or http://dx.doi.org/10.2139/ssrn.2810256

Venoo Kakar (Contact Author)

San Francisco State University ( email )

1600 Holloway Avenue
San Francisco, CA 94132
United States
4154053461 (Phone)
4153381057 (Fax)

HOME PAGE: http://www.venookakar.com

Stefano D'Addona

University of Roma Tre ( email )

Via Chiabrera, 199
Rome, 00145
Italy

Marcelle Chauvet

University of California Riverside ( email )

Department of Economics
4136 Sproul Hall
Riverside, CA 92527
United States
(951) 827-1587 (Phone)

HOME PAGE: http://sites.google.com/site/marcellechauvet/

University of California Riverside ( email )

Department of Economics
Riverside, CA 92527
United States

HOME PAGE: http://sites.google.com/site/marcellechauvet/

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