OPTIMAL MONETARY POLICY AND ASSET PRICE MISALIGNMENTS

  1. Alexandros Kontonikas1,
  2. Alberto Montagnoli2

Article first published online: 12 OCT 2006

DOI: 10.1111/j.1467-9485.2006.00398.x

Issue

Scottish Journal of Political Economy

Scottish Journal of Political Economy

Volume 53, Issue 5, pages 636–654, November 2006

Additional Information

How to Cite

Kontonikas, A. and Montagnoli, A. (2006), OPTIMAL MONETARY POLICY AND ASSET PRICE MISALIGNMENTS. Scottish Journal of Political Economy, 53: 636–654. doi: 10.1111/j.1467-9485.2006.00398.x

Author Information

  1. 1

    University of Glasgow

  2. 2

    University of Stirling

Publication History

  1. Issue published online: 12 OCT 2006
  2. Article first published online: 12 OCT 2006
  3. Date of receipt of final manuscript: 22 February 2006.

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Keywords:

  • Monetary policy;
  • Asset prices
  • E52;
  • E60;
  • G1

ABSTRACT

This paper analyses the relationship between monetary policy and asset prices in the context of optimal policy rules. The transmission mechanism is represented by a linearized rational expectations model augmented for the effect of asset prices on aggregate demand. Stabilization objectives are represented by a discounted quadratic loss function penalizing inflation and output gap volatility. Asset prices are allowed to deviate from their intrinsic value due to momentum trading. We find that in the presence of wealth effects and inefficient markets, asset price misalignments from their fundamentals should be included in the optimal interest rate reaction function.

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