Asymmetric Monetary Policy Towards the Stock Market: A DSGE Approach

TY - JOUR

T1 - Asymmetric Monetary Policy Towards the Stock Market

T2 - A DSGE Approach

AU - Ravn, Søren Hove

N1 - JEL Classification: E13, E32, E44, E52, E58

PY - 2014

Y1 - 2014

N2 - In the aftermath of the financial crisis, it has been argued that a guideline for the design of the future policy framework should be to take the 'a' out of 'asymmetry' in the way monetary policy deals with asset price movements. Recent empirical evidence has suggested that the Federal Reserve may have followed an asymmetric policy towards the stock market in the pre-crisis period. According to these findings, monetary policy in the US before the crisis involved a reaction to stock price drops, but no reaction to increasing stock prices. The present paper studies the effects of such a policy in a DSGE model. The asymmetric policy rule introduces an important non-linearity into the model: Booms in output and inflation tend to be amplified, while recessions are dampened. Moreover, such a policy gives rise to expectations-driven booms in asset prices. We further investigate to what extent an asymmetric stock price reaction could be motivated by the desire of policymakers to correct for inherent asymmetries in the way stock price movements affect the macroeconomy.

AB - In the aftermath of the financial crisis, it has been argued that a guideline for the design of the future policy framework should be to take the 'a' out of 'asymmetry' in the way monetary policy deals with asset price movements. Recent empirical evidence has suggested that the Federal Reserve may have followed an asymmetric policy towards the stock market in the pre-crisis period. According to these findings, monetary policy in the US before the crisis involved a reaction to stock price drops, but no reaction to increasing stock prices. The present paper studies the effects of such a policy in a DSGE model. The asymmetric policy rule introduces an important non-linearity into the model: Booms in output and inflation tend to be amplified, while recessions are dampened. Moreover, such a policy gives rise to expectations-driven booms in asset prices. We further investigate to what extent an asymmetric stock price reaction could be motivated by the desire of policymakers to correct for inherent asymmetries in the way stock price movements affect the macroeconomy.

U2 - 10.1016/j.jmacro.2013.11.002

DO - 10.1016/j.jmacro.2013.11.002

M3 - Journal article

SN - 0164-0704

VL - 39

SP - 24

EP - 41

JO - Journal of Macroeconomics

JF - Journal of Macroeconomics

IS - A

ER -