Working Paper: CEPR ID: DP4114
Authors: Jagjit S. Chadha; Lucio Sarno; Giorgio Valente
Abstract: We examine empirically whether asset prices and exchange rates may be admitted into a standard interest rate rule, using data for the US, the UK and Japan since 1979. Asset prices and exchange rates can be employed as information variables for a standard `Taylor-type' rule or as arguments in an augmented interest rate rule. Our empirical evidence, based on measures of the output gap proxied by marginal costs calculations, suggests that monetary policy-makers may use asset prices and exchange rates not only as part of their information set for setting interest rates, but also to set interest rates to offset deviations of asset prices or exchange rates from their equilibrium levels. These results are open to several alternative interpretations.
Keywords: asset prices; exchange rates; interest rate rules; monetary policy
JEL Codes: E40; E44; E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Interest rates (E43) | Inflation (E31) |
| Interest rates (E43) | Output (Y10) |
| Output gap (E23) | Interest rates (E43) |
| Real marginal costs (D40) | Interest rates (E43) |
| Asset prices (G19) | Interest rates (E43) |
| Exchange rates (F31) | Interest rates (E43) |