Chapter

Expectations, Asset Prices, and Monetary Policy

Simon Gilchrist and Masashi Saito

in Asset Prices and Monetary Policy

Published by University of Chicago Press

Published in print October 2008 | ISBN: 9780226092119
Published online February 2013 | e-ISBN: 9780226092126 | DOI: http://dx.doi.org/10.7208/chicago/9780226092126.003.0003
Expectations, Asset Prices, and Monetary Policy

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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.

Keywords: monetary authority; monetary policy; financial market imperfections; economic shocks; asset prices; financial accelerator mechanism; technology growth; inflation

Chapter.  18816 words.  Illustrated.

Subjects: Macroeconomics and Monetary Economics

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