Monetary Policy and Stock Market Boom-Bust Cycles
99 Pages Posted: 20 Nov 2008
Date Written: October 31, 2008
We explore the dynamic effects of news about a future technology improvement which turns out ex post to be overoptimistic. We find that it is difficult to generate a boom-bust cycle (a period in which stock prices, consumption, investment and employment all rise and then crash) in response to such a news shock, in a standard real business cycle model. However, a monetized version of the model which stresses sticky wages and a Taylor-rule based monetary policy naturally generates a welfare-reducing boom-bust cycle in response to a news shock. We explore the possibility that integrating credit growth into monetary policy may result in improved performance. We discuss the robustness of our analysis to alternative specifications of the labor market, in which wage-setting frictions do not distort on going firm/worker relations.
Keywords: DSGE Models, Monetary Policy, Asset price boom-busts
JEL Classification: C11, C51, E5, E13, E32
Suggested Citation: Suggested Citation