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Asset price and monetary policy: the effect of expectations formation

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  • Nan-Kuang Chen
  • Han-Liang Cheng
  • Hsiao-Lei Chu

Abstract

This article studies the stabilization effect of monetary policy reacting to asset price, accounting for the expectations formation effect of policy regime shift, in a DSGE model calibrated to the US economy. In contrast to the linear policy rule that generates negligible stabilization effect from responding to asset prices, the regime switching policy rule can significantly stabilize inflation-output volatilities. We then identify the range of parameter values that can generate stabilization effect for inflation and find that reacting to asset prices too aggressively can be inflation de-stabilizing. Given certain combinations of parameter values, the trade-off between the expected volatility of inflation and that of output, as demonstrated by the Taylor curve, substantially diminishes, thus considering non-linear policy rule expands the set of monetary policy choices available for monetary authority. Finally, there exists an optimal responsiveness to asset prices.

Suggested Citation

  • Nan-Kuang Chen & Han-Liang Cheng & Hsiao-Lei Chu, 2015. "Asset price and monetary policy: the effect of expectations formation," Oxford Economic Papers, Oxford University Press, vol. 67(2), pages 380-405.
  • Handle: RePEc:oup:oxecpp:v:67:y:2015:i:2:p:380-405.
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    File URL: http://hdl.handle.net/10.1093/oep/gpu045
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    References listed on IDEAS

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    1. Assenmacher-Wesche, Katrin & Gerlach, Stefan, 2008. "Ensuring financial stability: Financial structure and the impact of monetary policy on asset prices," IMFS Working Paper Series 16, Goethe University Frankfurt, Institute for Monetary and Financial Stability (IMFS).
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    3. Henrik Jensen, 2002. "Targeting Nominal Income Growth or Inflation?," American Economic Review, American Economic Association, vol. 92(4), pages 928-956, September.
    4. Katrin Assenmacher & Stefan Gerlach, 2008. "Financial Structure and the Impact of Monetary Policy on Asset Prices," Working Papers 2008-16, Swiss National Bank.
    5. Paolo Surico & Antonello D'Agostino & Luca Sala, 2005. "The Fed and the Stock Market," Computing in Economics and Finance 2005 293, Society for Computational Economics.
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    Cited by:

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    2. Charles Ka Yui LEUNG, 2022. "Housing and Macroeconomics," ISER Discussion Paper 1197, Institute of Social and Economic Research, Osaka University.
    3. Yongheng Deng & Eric Girardin & Roselyne Joyeux & Shuping Shi, 2017. "Did bubbles migrate from the stock to the housing market in China between 2005 and 2010?," Pacific Economic Review, Wiley Blackwell, vol. 22(3), pages 276-292, August.
    4. Yongheng Deng & Eric Girardin & Roselyne Joyeux, 2015. "Fundamentals and the Volatility of Real Estate Prices in China: A Sequential Modelling Strategy," Working Papers 222015, Hong Kong Institute for Monetary Research.
    5. Deng, Yongheng & Girardin, Eric & Joyeux, Roselyne, 2018. "Fundamentals and the volatility of real estate prices in China: A sequential modelling strategy," China Economic Review, Elsevier, vol. 48(C), pages 205-222.
    6. Tsai, I-Chun, 2019. "Dynamic price–volume causality in the American housing market: A signal of market conditions," The North American Journal of Economics and Finance, Elsevier, vol. 48(C), pages 385-400.
    7. Zheng Zheng Li & Chi-Wei Su, 2023. "How does real estate market react to the iron ore boom in Australian capital cities?," The Annals of Regional Science, Springer;Western Regional Science Association, vol. 71(2), pages 517-537, October.
    8. Zhou, Zhengyi, 2016. "Overreaction to policy changes in the housing market: Evidence from Shanghai," Regional Science and Urban Economics, Elsevier, vol. 58(C), pages 26-41.
    9. Xin He & Zhenguo Lin & Yingchun Liu & Michael J. Seiler, 2020. "Search Benefit in Housing Markets: An Inverted U‐Shaped Price and TOM Relation," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 48(3), pages 772-807, September.

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    More about this item

    JEL classification:

    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G1 - Financial Economics - - General Financial Markets

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