Monetary Policy and Stock Prices in an Open Economy

Authors


  • Paper presented at the XLVI Annual Meeting of the Italian Economic Society (SIE), the Ente Einuaudi 40th Anniversary Conference, and the JBF/Guanghua School of Management Conference in Beijing. We wish to thank Marco Airaudo, Pierpaolo Benigno, Olivier Loisel, Giorgio Primiceri, Zeno Rotondi, and participants to seminars held at the Banque de France, the IMF Research Department, LUISS Guido Carli, University of Ancona, and Utrecht School of Economics for comments. Two anonymous referees also provided valuable suggestions. The usual disclaimer applies. Financial Support from MIUR, Cofin 2004, is gratefully acknowledged.

Abstract

This paper studies monetary policy in a two-country model where agents can invest their wealth in both stock and bond markets. In our economy the foreign country hosts the only active equity market where also residents of the home country can trade stocks of listed foreign firms. We show that, in order to achieve price stability, the Central Banks in both countries should grant a dedicated response to movements in stock prices driven by relative productivity shocks. Determinacy of rational expectations equilibria and approximation of the Wicksellian interest rate policy by simple monetary policy rules are also investigated.

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