Monetary Policy and Stock Market Booms
Historical data and model simulations support the following conclusion. Inflation is low during stock market booms, so that an interest rate rule that is too narrowly focused on inflation destabilizes asset markets and the broader economy. Adjustments to the interest rate rule can remove this source of welfare-reducing instability. For example, allowing an independent role for credit growth (beyond its role in constructing the inflation forecast) would reduce the volatility of output and asset prices.
Prepared for Macroeconomic Challenges: the Decade Ahead, A Symposium Sponsored by the Federal Reserve Bank of Kansas City Jackson Hole, Wyoming August 26 - 28, 2010. The views expressed in this paper are those of the authors and do not necessarily reflect those of the ECB, the Eurosystem, or the National Bureau of Economic Research. We are grateful for discussions with David Altig, Gadi Barlevy, Martin Eichenbaum, Ippei Fujiwara and Jean-Marc Natal, and for comments from John Geanakoplos. We have also benefited from the advice and assistance of Daisuke Ikeda and Patrick Higgins.
Lawrence Christiano & Cosmin Ilut & Roberto Motto & Massimo Rostagno, 2010. "Monetary policy and stock market booms," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 85-145. citation courtesy of