Citation

Discussion Paper Details

Please find the details for DP1751 in an easy to copy and paste format below:

Full Details   |   Bibliographic Reference

Full Details

Title: Financial Asset Prices and Monetary Policy: Theory and Evidence

Author(s): Frank Smets

Publication Date: November 1997

Keyword(s): Asset Prices, MCI and Monetary Policy

Programme Area(s): International Macroeconomics

Abstract: The work presented in this paper falls into two parts. First, using a simple model and within the context of the central bank?s objective of price stability, it is shown that the optimal monetary response to unexpected changes in asset prices depends on how these changes affect the central bank?s inflation forecast, which in turn depends on two factors: the role of the asset price in the transmission mechanism and the typical information content of innovations in the asset price. In this context, the advantages and disadvantages of setting monetary policy in terms of a weighted average of a short-term interest rate and an asset price such as the exchange rate ? a Monetary Conditions Index (MCI) ? are discussed. The second, more empirical, part of the paper, uses an estimated policy reaction function, to document the short-term response to financial asset prices, including the exchange rate, in two countries with inflation targets (Australia and Canada) and suggests that the different response to exchange rate changes in these countries can in part be explained by differences in their underlying sources.

For full details and related downloads, please visit: https://cepr.org/active/publications/discussion_papers/dp.php?dpno=1751

Bibliographic Reference

Smets, F. 1997. 'Financial Asset Prices and Monetary Policy: Theory and Evidence'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=1751