Inclusion of Asset Prices: An Argument for Monetary Policy and the Phillips Curve

Abstract

Abstract This article develops an augmented price index that includes house prices, so that the relationship between inflation and unemployment levels in the traditional Phillips curve can be better represented. This general price index may be considered complementary to the Harmonised Index of Consumer Prices (HICP) and establishes the model-theoretical basis for a new-Keynesian model that derives the conditions for a monetary policy rule in a dynamic stochastic optimization procedure. Based on a simple stochastic differential equation for augmented inflation, we show that the reaction of the central bank depends on the marginal effects on augmented inflation and the output gap of an infinitesimal change in asset prices. This analysis could be interpreted as a way of using asset prices for a general price index, being an adequate method to restore monetary credibility. JEL classifications: E52, E58, G10 Keywords: monetary policy, asset prices, Phillips curve