Optimal monetary policy and asset price misalignments

Citation

Kontonikas A & Montagnoli A (2006) Optimal monetary policy and asset price misalignments. Scottish Journal of Political Economy, 53 (5), pp. 636-654. https://doi.org/10.1111/j.1467-9485.2006.00398.x

Abstract
This paper analyses the relationship between monetary policy and asset prices in the context of optimal policy rules. The transmission mechanism is represented by a linearized rational expectations model augmented for the effect of asset prices on aggregate demand. Stabilization objectives are represented by a discounted quadratic loss function penalizing inflation and output gap volatility. Asset prices are allowed to deviate from their intrinsic value due to momentum trading. We find that in the presence of wealth effects and inefficient markets, asset price misalignments from their fundamentals should be included in the optimal interest rate reaction function.

Keywords
Monetary policy; Asset prices

Journal
Scottish Journal of Political Economy: Volume 53, Issue 5