11. Stock Prices and Monetary Policy
- Author:
- Paul De Grauwe
- Publication Date:
- 09-2008
- Content Type:
- Working Paper
- Institution:
- Centre for European Policy Studies
- Abstract:
- The question of whether central banks should target stock prices so as to prevent bubbles and crashes from occurring has been hotly debated. We analyse this question using a behavioural macroeconomic model. This model generates bubbles and crashes. We analyse how 'leaning against the wind' strategies, which aim to reduce the volatility of stock prices, can help in reducing volatility of output and inflation. We find that such policies can be effective in reducing macroeconomic volatility, thereby improving the trade- off between output and inflation variability. The strength of this result, however, depends on the degree of credibility of the inflation-targeting regime. In the absence of such credibility, policies aiming at stabilising stock prices do not stabilise output and inflation.
- Topic:
- Economics, Foreign Exchange, and International Trade and Finance