Expectations, Asset Prices, and Monetary Policy: The Role of Learning

74 Pages Posted: 24 Aug 2006 Last revised: 2 Jul 2010

See all articles by Simon Gilchrist

Simon Gilchrist

Boston University - Department of Economics; National Bureau of Economic Research (NBER)

Masashi Saito

Bank of Japan - Institute for Monetary and Economic Studies

Date Written: August 2006

Abstract

This paper studies the implications of financial market imperfections represented by a countercyclical external finance premium and the gradual recognition of changes in the drift of technology growth for the design of an interest rate rule. Asset price movements induced by changes in trend growth influence balance-sheet conditions that determine the external finance premium. Such movements are magnified when the private sector is imperfectly informed regarding the trend growth rate of technology. The presence of financial market imperfections provides a motivation for responding to the gap between the observed asset prices and the potential level of asset prices in addition to responding strongly to inflation. This is because the asset price gap represents distortions in the resource allocation induced by financial market imperfections more distinctly than inflation. The policymaker's imperfect information about the drift of technology growth renders imprecise the calculation of the potential and thus reduces the benefit of responding to the asset price gap. A policy that responds to the level of asset prices which does not take into account changes in potential tends to be welfare reducing.

Suggested Citation

Gilchrist, Simon and Saito, Masashi, Expectations, Asset Prices, and Monetary Policy: The Role of Learning (August 2006). NBER Working Paper No. w12442. Available at SSRN: https://ssrn.com/abstract=913301

Simon Gilchrist (Contact Author)

Boston University - Department of Economics ( email )

270 Bay State Road
Boston, MA 02215
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Masashi Saito

Bank of Japan - Institute for Monetary and Economic Studies ( email )

2-1-1, Hongoku-cho
Nihonbashi
Chuo-ku, Tokyo, 103
Japan

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