CXO

Asset Price And Monetary Policy - The Effect Of Expectation Formation

Date Added: Jan 2011
Format: PDF

This paper is a theoretical study of the effects of monetary policy reacting to fluctuations in asset price, accounting for the expectation formation effect of policy regime shift in a DSGE model calibrated to the U.S. economy. The authors find that the effect of expectation formation can substantially influence the movement of asset price. In contrast to the linear policy rule, under the regime switching policy rule reacting to asset price can generate substantial stabilization effect: the "Expected" inflation-output volatility frontier shifts downward, thereby lowering both the volatilities of inflation and output for all possible policy choices.