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Asset price targeting in an open economy with cognitive limitations: The best for macroeconomic and financial stability?

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  • Yeh, Kuo-chun

Abstract

The choices of policy targets and the formation of agent expectations have been critical issues addressed by monetary policy management since the financial crisis of 2008. This paper evaluates macroeconomic stability in a new Keynesian open economy in which agents experience both cognitive limitations and asset market volatility. The (im)perfect credibility of various monetary policies (e.g., a Taylor-type rule with- or without asset price targeting, strict domestic inflation targeting, strict CPI inflation targeting, and exchange rate peg) may lead agents to react according to their expectation rules, and thus create various degrees of booms and busts in output and inflation. Simulations confirm that a Taylor-type CPI inflation targeting including an asset price target is the best choice. In contrast, the business cycles induced by Keynesian “animal spirits” are enhanced by strict inflation targeting. Furthermore, a credible exchange rate pegging system with an international reserve pooling arrangement can improve social welfare and stability in an open economy, even though its absolute value of the loss function is slightly lower than a Taylor-type CPI inflation targeting including an asset price target.

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  • Yeh, Kuo-chun, 2017. "Asset price targeting in an open economy with cognitive limitations: The best for macroeconomic and financial stability?," The North American Journal of Economics and Finance, Elsevier, vol. 39(C), pages 288-299.
    • Handle: RePEc:eee:ecofin:v:39:y:2017:i:c:p:288-299
    DOI: 10.1016/j.najef.2016.10.012
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    Cited by:

    1. Wang, Shengquan & Chen, Langnan, 2019. "Driving factors of equity bubbles," The North American Journal of Economics and Finance, Elsevier, vol. 49(C), pages 304-317.

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    More about this item

    Keywords

    Asset prices; Heuristics; Rational expectations; Monetary policy rules; New Keynesian open economy;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation: Models and Applications
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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