Working Paper: NBER ID: w16402
Authors: Lawrence Christiano; Cosmin L. Ilut; Roberto Motto; Massimo Rostagno
Abstract: Historical data and model simulations support the following conclusion. Inflation is low during stock market booms, so that an interest rate rule that is too narrowly focused on inflation destabilizes asset markets and the broader economy. Adjustments to the interest rate rule can remove this source of welfare-reducing instability. For example, allowing an independent role for credit growth (beyond its role in constructing the inflation forecast) would reduce the volatility of output and asset prices.
Keywords: monetary policy; stock market; booms; inflation; credit growth
JEL Codes: E42; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| low inflation (E31) | stock market boom (G10) |
| low inflation (E31) | interest rate cuts (E43) |
| interest rate cuts (E43) | increased stock prices (G10) |
| low inflation (E31) | increased stock prices (G10) |
| interest rate targeting rule focused on inflation forecasts (E52) | asset market instability (E44) |
| credit growth (E51) | stabilization of booms (E32) |