Monetary policy and asset prices: to respond or not?

Abstract

We investigate whether there is a case for asset prices in interest rates rules within a small econometric model of the Norwegian economy, modeling the interdependence of the real economy, credit and three classes of assets prices: housing prices, equity prices and the nominal exchange rate. We compare the performance of simple and efficient interest rate rules that allow for response to movements in asset prices to the performance of more standard monetary policy rules. We find that including housing prices and equity prices in the policy rules can improve macroeconomic performance in terms of both nominal and real economic stability.In contrast, a response to nominal exchange rate fluctuations can induce excess volatility in general and prove detrimental to macroeconomic stability.

Model Selection for Monetary Policy Analysis: How Important is Empirical Validity?*

“…We condition on the variables pr t , pi t , u t and Δ y t , as these variables have been found to be weakly exogenous with respect to the parameters defining cointegration vectors and the associated adjustment coefficients. In particular, the cointegrating relationships for wages and prices are statistically insignificant in the dynamic models for these variables (see Akram et al , 2005). The weak exogeneity assumption has also been tested, and not rejected, by Bårdsen et al (2003) on an earlier vintage of the data set employed in this paper.…”

“…The macroeconometric model is a version of the model developed in Bårdsen et al. (2005), which has been documented and employed in several studies, including Akram et al (2005) 10 . The model is (log) linear and estimated on quarterly aggregate data for the period 1972–2001.…”

“…The three systems may be considered alternative blocks of the supply side in a macroeconometric model for medium‐term analysis. To close each of the three systems, we conduct our policy analysis by embedding, in turn, the three wage and price systems in a well‐specified macroeconometric model of Norway (see Bårdsen et al , 2005; Akram, Bårdsen and Eitrheim, 2005). This model is part of the suite of models maintained by Norges Bank.…”

Central banks’ voting contest

“…It is well known that overactive monetary policy might well result in destabilisation (e.g. Akram, Bärsden, and Eithreim, 2006;Charemza and Ladley, 2016), while a constantly passive policy might be no policy at all. It should be stressed that this paper is not about the timing of monetary decisions like Olivei and Teeyro (2007) and Choi, Eisenbach, and Yorulmazer (2016) are.…”

Owner-occupied housing in a model of exchange rate determination

“…For example, Akraim et al (2005) estimate the links between the exchange rate, housing and other financial assets and the effect of monetary shocks on the interest rate. The study finds that ''exchange rates may have direct effects on inflation through imported inflation, while housing and equity prices may affect inflation and output through their effects on credit growth, aggregate consumption and investment'' (Akraim et al, 2005). In our context, we want to look at the relationship between exchange rates and housing.…”