Abstract
Carlstrom and Fuerst [“Asset Prices, Nominal Rigidities, and Monetary Policy,” Review of Economic Dynamics, Vol. 10, 2007, pp. 256-275] find that a positive monetary policy response to share prices is a source of equilibrium indeterminacy. In this note, we investigate the negative response of a central bank to share prices. We find that a negative monetary policy response to share prices is also a source of equilibrium indeterminacy.
Highlights
IntroductionTo this classic monetary policy question, a recent paper by Carlstrom and Fuerst [1] provides a negative answer
Should monetary policy respond to asset price fluctuations? To this classic monetary policy question, a recent paper by Carlstrom and Fuerst [1] provides a negative answer
The effects of monetary policy responses to asset prices are investigated. [1] found that a positive monetary policy response is a source of equilibrium indeterminacy since it implies that the monetary policy response to share price implicitly weakens the overall reaction to inflation
Summary
To this classic monetary policy question, a recent paper by Carlstrom and Fuerst [1] provides a negative answer They find that equilibrium indeterminacy arises if monetary policy positively responds to share prices in a standard sticky-price economy. The monetary policy response to share prices implicitly weakens the overall reactions to inflation This is a source of equilibrium indeterminacy in their model. The work by Faia and Monacelli [2] is closely related to this conjecture They find that the optimal monetary policy is to respond to asset prices negatively in a sticky price model with financial frictions a la Carlstrom and Fuerst [3]. To address this question, we extend the model of [1] where a central bank can respond to asset prices negatively.
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