Abstract
This study investigates the monetary policy rule including money growth and optimal Ramsey policy in restraining the stock market Fluctuations. We apply a new Keynesian monetary framework with nominal wage and price rigidities within a DSGE model for Iranian economy. Bubbles in our model emerge through a positive feedback loop mechanism supported by self-fulfilling beliefs. The sentiment shock, which represents the size of current bubbles relative to newly born bubbles, causing bubbles movement and it transfers to the real economy through endogenous credit constraint. Moreover, this study investigates the impulse and response between sentiment shock and fluctuation in aggregate variables. Our empirically findings show that: first, applying Ramsey optimal monetary policy decreases the central bank’s loss function, relative to monetary policy rule with money growth. Second, the sentiment shock drives the movements of stock market fluctuations and variations in real economy, leading to explain the positive contemporaneous correlation between stock prices and the real economy and it helps explaining the business cycles in Iran.
Highlights
This study investigates the monetary policy rule including money growth and optimal Ramsey policy in restraining the stock market Fluctuations
This paper investigates the monetary policy rule in restraining the stock market fluctuations with applying dynamic stochastic general equilibrium models under two alternative monetary policy rule, one with money growth and the other with optimal Ramsey policy respectively, since there is not any empirical and theoretical study on assessing the relationship between monetary policy and asset market bubbles for Iranian economy
We develop Ikeda’s monetary dynamic stochastic general equilibrium (DSGE) model with appropriate framework for Iranian economy, and this study contributes to the literature in several aspects compare to Ikeda’s
Summary
This study investigates the monetary policy rule including money growth and optimal Ramsey policy in restraining the stock market Fluctuations. This study investigates the impulse and response between sentiment shock and fluctuation in aggregate variables. The sentiment shock drives the movements of stock market fluctuations and variations in real economy, leading to explain the positive contemporaneous correlation between stock prices and the real economy and it helps explaining the business cycles in Iran. Identifying the monetary policy conduction in a stock market bubble and the appropriate policy responses to these fluctuations and their impacts on macroeconomic variables are important. Many authors and policy makers argue on appropriate response to asset prices and financial conditions specially and more broadly during financial crises
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