Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/268307 
Authors: 
Year of Publication: 
2023
Publisher: 
ZBW - Leibniz Information Centre for Economics, Kiel, Hamburg
Abstract: 
Departures from full-information rational expectation models give rise to stock price wealth effects which introduce inefficient cyclical fluctuations in the economy. Waves of optimism/pessimism affect beliefs and asset prices which influence aggregate demand through expectation-driven wealth effects. Monetary policy can play an important role in eliminating the non-fundamental effects of belief-driven asset price cycle: reacting symmetrically and transparently to stock prices increases welfare significantly compared to flexible inflation targeting strategies. A quantitative model estimated on US data shows that increasing interest rates by 12 basis points for every 100% rise in stock prices accomplish this goal. Moreover, a nonlinear reaction to stock prices only when capital gains exceed 7% delivers similar efficiency gains.
Subjects: 
monetary policy
wealth effects
learning
survey expectations
stock prices
animal spirits
JEL: 
D84
E32
E44
E52
Document Type: 
Working Paper

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