Asset Prices in a Flexible Inflation Targeting Framework

24 Pages Posted: 30 May 2002 Last revised: 27 Oct 2010

See all articles by Stephen G. Cecchetti

Stephen G. Cecchetti

Brandeis International Business School; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Hans Genberg

University of Geneva - Graduate Institute of International Studies (HEI)

Sushil Wadhwani

Bank of England - Monetary Policy Committee

Date Written: May 2002

Abstract

We argue that there are sound theoretical reasons for believing that an inflation targeting central bank might improve macroeconomic performance by reacting to asset price misalignments over and above the deviation of, say, a two-year ahead inflation forecast from target. In this paper, we first summarize the arguments for our basic proposition. We then discuss some of the counter-arguments. Specifically, we counter those who argue that reacting to asset prices does not improve macroeconomic performance by claiming that they are attacking the 'straw man' under which central bankers react in the same way to all asset price changes. We continue to emphasize that policy reactions to asset price misalignments must be qualitatively different from reactions to asset prices changes driven by fundamentals. Hence, we stand by our earlier results and conclusions. In practice, we do believe that central bankers can detect large misalignments (e.g. the Nikkei in 1989 or the NASDAQ in early 2000), and that they might be in a better position to react to long-lived bubbles than many market participants. However, we recognize that our proposal may present communication challenges, and it is critically important that policy set to react to asset price misalignments both be explained well and that it be based on a broad consensus. It is also important to emphasize that our proposal is wholly consistent with the remit of most inflation-targeting central banks, as we are recommending that while they might react to asset price misalignments, they must not target them.

Suggested Citation

Cecchetti, Stephen G. and Genberg, Hans and Wadhwani, Sushil, Asset Prices in a Flexible Inflation Targeting Framework (May 2002). NBER Working Paper No. w8970. Available at SSRN: https://ssrn.com/abstract=314641

Stephen G. Cecchetti (Contact Author)

Brandeis International Business School ( email )

415 South Street
Waltham, MA 02453
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States
212-720-8629 (Phone)
212-720-2630 (Fax)

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Hans Genberg

University of Geneva - Graduate Institute of International Studies (HEI) ( email )

PO Box 136
Geneva, CH-1211
Switzerland
+41 22 908 5928 (Phone)

Sushil Wadhwani

Bank of England - Monetary Policy Committee ( email )

Threadneedle Street
London EC2R 8AH
United Kingdom
+44 20 7601 3235 (Phone)

Register to save articles to
your library

Register

Paper statistics

Downloads
142
Abstract Views
2,354
rank
201,885
PlumX Metrics