Abstract:
This paper studies the implications for optimal monetary policy associated to the wealth effects induced by stock-price dynamics within a non-Ricardian framework. We use a new Keynesian model incorporating households with perpetual youth to study whether a monetary rule responding to asset price fluctuations could find sizeable welfare improvements with respect to pursuing a policy tracking flexible price allocations. First, we find that, for different types of shocks (i.e. productivity, demand, and financial), pursuing optimal policies can provide sizeable reductions in the social welfare loss with respect to flexible price allocations. Second, we study whether a monetary policy rule tracking the natural rate and responding to asset price fluctuations can attain reductions in the welfare losses close to the magnitude found by pursuing optimal policies. We find that such a rule is effective to attain optimal outcomes when the economy faces productivity shocks and financial shocks. However, we find that such rule can attain marginal reduction in the welfare losses when the economy faces demand shocks.
