Stock Price Wealth Effects and Monetary Policy under Imperfect Knowledge

Adrian Ifrim

EconStor Preprints from ZBW - Leibniz Information Centre for Economics

Abstract: Departures from full-information rational expectation models give rise to stock price wealth effects which introduce inefficient cyclical fluctuations in the economy. Waves of optimism/pessimism affect beliefs and asset prices which influence aggregate demand through expectation-driven wealth effects. Monetary policy can play an important role in eliminating the non-fundamental effects of belief-driven asset price cycle: reacting symmetrically and transparently to stock prices increases welfare significantly compared to flexible inflation targeting strategies. A quantitative model estimated on US data shows that increasing interest rates by 12 basis points for every 100% rise in stock prices accomplish this goal. Moreover, a nonlinear reaction to stock prices only when capital gains exceed 7% delivers similar efficiency gains.

Keywords: monetary policy; wealth effects; learning; survey expectations; stock prices; animal spirits (search for similar items in EconPapers)
JEL-codes: D84 E32 E44 E52 (search for similar items in EconPapers)
Date: 2023
New Economics Papers: this item is included in nep-cba, nep-dge, nep-fdg and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:esprep:268307

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