Stock Prices and Monetary Policy: Re-Examining the Issue in a New Keynesian Model with Endogenous Investment

37 Pages Posted: 18 Jan 2012

See all articles by Michele Grossi

Michele Grossi

University of Trento - Department of Economics and Management

Roberto Tamborini

University of Trento - Department of Economics and Management

Multiple version iconThere are 3 versions of this paper

Date Written: 2011

Abstract

In this paper, the authors present a New Keynesian quantitative model with endogenous investment and a stock-market sector to shed further light on two unsettled issues: whether central banks should include some financial indicator in their policy rules, and what indicator may be expected to generate better stabilization performance. For comparative purposes, the authors replicate the policy framework and assessment strategy of the well-known no-inclusion model of Bernanke-Gertler (1999, 2000) and assess performance of five policy rules. Two of these are traditional Taylor rules (i.e., do not incorporate financial indicators) that differ in the relative weight they put on output and inflation gaps. The other three are financial Taylor rules. These involve the addition of one financial indicator in each case. Specifically, the deviation from trend of stock prices, of Tobin's q (the rate of change in stock prices relative to capital stock) and of investment. The authors obtain results that are at variance with Bernanke-Gertler, first, because the best performing rule of the traditional rules is output aggressive instead of inflation aggressive and, second, because the financial rule with Tobin's q outperforms the traditional inflation-aggressive one under all dimensions and cases. However, the authors cannot draw a univocal conclusion as regards the comparison between the financial rule with Tobin's q and the traditional but output aggressive rule.

Keywords: New Keynesian models, monetary policy, stock markets and bubbles

JEL Classification: E5, E52

Suggested Citation

Grossi, Michele and Tamborini, Roberto, Stock Prices and Monetary Policy: Re-Examining the Issue in a New Keynesian Model with Endogenous Investment (2011). Economics Discussion Paper No. 2011-54, Available at SSRN: https://ssrn.com/abstract=1987326 or http://dx.doi.org/10.2139/ssrn.1987326

Michele Grossi (Contact Author)

University of Trento - Department of Economics and Management ( email )

Via Inama 5
Trento, I-38100
Italy

Roberto Tamborini

University of Trento - Department of Economics and Management ( email )

Via Inama 5
Trento, I-38100
Italy

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