TABLE OF CONTENTS
Acknowledgments
Introduction - John Y. Campbell
DOI: 10.7208/chicago/9780226092126.003.0001
[National Bureau of Economic Research, asset prices, monetary policy, macroeconomic stability, moneatry authorities]
This volume is a collection of papers presented at a National Bureau of Economic Research (NBER) conference at the Wequassett Inn in Chatham, Massachusetts, on May 5–6, 2006. The papers explore the relationship between asset prices and monetary policy from the point of view of macroeconomic stability. Several papers ask what monetary authorities can learn. Asset prices are treated not as ultimate goals of monetary policy, nor as variables that can be directly controlled, but as indicators of macroeconomic conditions to which monetary authorities can respond. An overview of these contributions is presented. (pages 1 - 8)
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Measuring the Macroeconomic Risks Posed by Asset Price Booms - Stephen G. Cecchetti
DOI: 10.7208/chicago/9780226092126.003.0002
[housing prices, equity, risk management, economic growth, inflation, GDP, asset price booms]
This chapter examines equity and housing price booms and crashes from a risk management perspective. Using equity price data from twenty seven countries and housing price data from seventeen countries, it looks at the various consequences of rising equity and housing prices for growth and inflation. It begins by examining how asset price booms influence the mean and variance of deviations in output and price level from their (time-varying) trends. It then proceeds to measure both the GDP at risk and the price level at risk that these booms create. The results shows that housing booms are bad in virtually every way imaginable; they drive the output gap down, increase its volatility, increase GDP at risk, and push the lower tail of outcomes even lower. By contrast, equity booms have little impact on either the level or volatility of the output and price-level gaps at horizons of three years; do not change GDP at risk, but increase the risk of prices falling dramatically below trend; and drive the lower tail (ETL) even lower. (pages 9 - 34)
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Expectations, Asset Prices, and Monetary Policy - Simon Gilchrist, Masashi Saito
DOI: 10.7208/chicago/9780226092126.003.0003
[monetary authority, monetary policy, financial market imperfections, economic shocks, asset prices, financial accelerator mechanism, technology growth, inflation]
This chapter considers the design of monetary policy rule in an environment where both the private sector and the monetary authority learn about the trend growth rate of technology. In the presence of financial market imperfections resulting from asymmetric information between lenders and borrowers, shocks to the economy that cause increases in asset prices improve the balance-sheet conditions of borrowers, reduce the external finance premium, and amplify the response of real economic activity. This amplification mechanism—the financial accelerator mechanism—represents a distortion in underlying economic activity that can only partially be eliminated by a policy of responding strongly to inflation. It is also shown that the overall gains from allowing the monetary authority to respond to the asset price gap are greatest when the monetary authority can correctly identify the true state of technology growth, while the private sector must infer it from past observations of technology growth. (pages 45 - 100)
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Optimal Monetary Policy with Collateralized Household Debt and Borrowing Constraints - Tommaso Monacelli
DOI: 10.7208/chicago/9780226092126.003.0004
[monetary policy, private debt, collateral constraint, borrowing, inflation]
This chapter lays out a framework for the analysis of optimal monetary policy in the presence of nominal private debt and of a collateral constraint on borrowing. The emergence of a borrowing-lending decision in the equilibrium of our economy requires heterogeneity between a patient and an impatient agent. At the margin, and relative to a standard representative agent economy with price stickiness, optimal policy in this context requires a partial use of inflation volatility with a redistributive motive. However, the fact that, due to the presence of price stickiness, inflation movements are costly heavily biases the optimal policy prescription toward low inflation volatility. When durable prices have the additional effect of altering the value of the collateral and in turn the ability of borrowing, optimal policy has a motive for partially stabilizing the relative price of durables. (pages 103 - 141)
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Inflation Illusion, Credit, and Asset Prices - Monika Piazzesi, Martin Schneider
DOI: 10.7208/chicago/9780226092126.003.0005
[inflation, asset prices, house prices, borrowing, housing, stock prices, interest rates, stocks]
This chapter considers the effect of inflation illusion on asset prices in a general equilibrium model with heterogeneous agents. The model predicts a nonmonotonic relationship between house price-rent ratios and inflation: house prices are high whenever inflation is far away from its historical average. According to the model, a high-inflation environment—such as the 1970s—is a time when smart households drive up house prices because they are able to borrow cheaply from illusionary households. The latter do not realize that nominal rates are high only because expected inflation is high and thus perceive higher real rates than smart households. In contrast, in a low-inflation environment—such as the 2000s—the role of the two groups is reversed: illusionary households drive up house prices because they think they are borrowing cheaply from smart households. They do not realize that nominal interest rates are low only because of low expected inflation and thus perceive lower real rates than smart households. The cross-country evidence in this chapter also shows that the price-dividend ratios of housing and stocks often move in opposite directions. (pages 147 - 181)
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Learning, Macroeconomic Dynamics, and the Term Structure of Interest Rates - Hans Dewachter, Marco Lyrio
DOI: 10.7208/chicago/9780226092126.003.0006
[macroeconomic model, learning, inflation, interest rates, Kalman gain updating rule, Keynesian model, long-maturity yields, term structure]
This chapter builds and estimates a macroeconomic model that includes learning. Learning was introduced in the model by assuming that agents do not believe in time-invariant inflation targets nor in constant equilibrium real rates. Given these priors, the optimal learning rule was derived in terms of a Kalman gain updating rule. The results show that including learning improves the fit of the model independently of the type of information included in the measurement equation. Although learning models improve on the rational expectations models, they are not fully satisfactory. Autocorrelation in the errors was found to be significant. Introducing learning in a standard New Keynesian model generated sufficiently volatile stochastic endpoints to fit the variation in long-maturity yields and in surveys of inflation expectations. The learning model, therefore, complements the current macrofinance literature linking macroeconomic and term structure dynamics. (pages 191 - 244)
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Revealing the Secrets of the Temple - Glenn D. Rudebusch, John C. Williams
DOI: 10.7208/chicago/9780226092126.003.0007
[central bankers, monetary policy, central bank transparency, interest rate projections]
This chapter examines the unresolved debate among central bankers and researchers about the value of the direct signaling of policy intentions. The chapter is organized as follows. Section 6.2 describes the real-world direct signaling of policy inclinations by central banks and outlines some of the arguments for and against such transparency. Sections 6.3 and 6.4 examine the macroeconomic effects of direct revelation of a central bank's expectations about the future path of the policy rate in a small theoretical model, in which private agents have imperfect information about the determination of monetary policy. In particular, it focuses on the desirability of central bank transparency about the expected path of policy when the public is uncertain about the central bank's preferences and, therefore, the future path of policy. It is shown that publication of interest rate projections better aligns the expectations of the public and the central bank. Under reasonable conditions, improving the alignment of expectations helps the central bank better meet its goals, providing support for full central bank transparency. (pages 247 - 284)
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The Effect of Monetary Policy on Real Commodity Prices - Jeffrey A. Frankel
DOI: 10.7208/chicago/9780226092126.003.0008
[commodities, monetary policy, price index, interest rates, oil, mineral, agricultural products, commodity prices]
This chapter examines the connections between commodities and monetary policy. The main argument is that monetary policy, as reflected in real interest rates, is an important—and usually underappreciated—determinant of the real prices of oil and other mineral and agricultural products. It analyzes the monetary influences on commodity prices—first for a large country, then for a small one. It concludes with a viewpoint based on reverse causality: the possible influence of commodity prices on monetary policy in a consideration of what price index to use for the nominal anchor. (pages 291 - 327)
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Noisy Macroeconomic Announcements, Monetary Policy, and Asset Prices - Roberto Rigobon, Brian Sack
DOI: 10.7208/chicago/9780226092126.003.0009
[asset prices, monetary policy, macroeconomic data, interest rates]
This chapter focuses on measuring the reaction of asset prices and monetary policy expectations to the “true” economic news embedded in the major U.S. data releases. Rather than attempting to better measure the data or the expectations, it focuses on developing econometric techniques that will adequately deal with the measurement problems associated with the data surprises used in the existing event-study literature. The results provide unbiased estimates of the response of monetary policy expectations and asset prices to the “true” surprise contained in all of the major data releases. An important finding is that macroeconomic data releases matter to a much greater extent than found in previous studies—that is, they account for a greater portion of the fluctuations in market interest rates. (pages 335 - 369)
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Is Bad News about Inflation Good News for the Exchange Rate? - Richard H. Clarida, Daniel Waldman
DOI: 10.7208/chicago/9780226092126.003.0010
[asset price, exchange rate, inflation, monetary policy, Taylor Rule]
This chapter asks whether the response of an asset price (in this case the exchange rate) to a nonpolicy shock (in this case a surprise in inflation) can tell us something about how monetary policy is conducted. It shows in a simple, but robust, theoretical monetary exchange rate model that the sign of the covariance between an inflation surprise and the nominal exchange rate can tell us something about how monetary policy is conducted. Specifically, it shows that “bad news” about inflation—that it is higher than expected—can be “good news” for the nominal exchange rate—that it appreciates on this news—if the central bank has an inflation target that it implements with a Taylor Rule. (pages 371 - 396)
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Remarks - Donald L. Kohn, Laurence H. Meyer, William C. Dudley
DOI: 10.7208/chicago/9780226092126.003.0011
[panel discussion, Donald L. Kohn, Laurence H. Meyer, William C. Dudley, Federal Reserve, Goldman Sachs, Macroeconomic Advisers LLC, asset markets]
This chapter presents a panel discussion among three distinguished practitioners: Governor Donald L. Kohn of the Federal Reserve; former Governor Laurence H. Meyer, now vice chairman of Macroeconomic Advisers LLC; and William C. Dudley, advisory director of Goldman, Sachs & Co. The three panelists share the view that asset markets periodically develop “bubbles,” upward price movements that cannot easily be justified by fundamentals and that often end in sharp declines. (pages 397 - 420)
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Contributors
Author Index
Subject Index
