Monetary Policy and Behavioral Finance
42 Pages Posted: 10 Oct 2006
Date Written: August 2006
There have been major advances in both theory and econometric techniques in mainstream macro-models and parallel advances in knowledge of the monetary transmission mechanism acting via asset prices. At the same time, behavioral finance has provided evidence that not all actors in the economy are 'fully rational' and this has influenced models of asset pricing on which part of the monetary policy transmission mechanism depends. Such uncertainty about the behaviour of asset prices has in part stimulated a move towards 'robustness', as an important criterion for guiding monetary policy. We argue that although we have discovered much, including 'what not to do', nevertheless our knowledge of the transmission mechanism is very incomplete. This is because, in spite of all the theoretical advances that have been made, there is still considerable uncertainty over the behaviour of agents, which has been reinforced by insights from behavioral finance.
Keywords: Monetary policy, behavioral finance, financial markets
JEL Classification: E51, E61, G12
Suggested Citation: Suggested Citation
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By Anna Florio