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Seoul Journal of Economics
[ Article ]
Seoul Journal of Economics - Vol. 23, No. 1, pp.35-55
ISSN: 1225-0279 (Print)
Print publication date 28 Feb 2010
Received 27 Oct 2009 Revised 05 Nov 2009

Should the Federal Reserve Have Responded to Asset Prices?

Jangryoul Kim ; Sungjin Cho
Associate Professor, Department of International Economics and Law, Hankuk University of Foreign Studies, Seoul 130-791, Korea, Tel: +82-2-2173-3225 kjryoul@hufs.ac.kr
Corresponding Author, Assistant Professor, Department of Economics, Seoul National University, Seoul 151-742, Korea, Tel: +82-2-880-6371, Fax: +82-2-886-4231 sungcho@snu.ac.kr

JEL Classification: E21, D12, D91

Abstract

Determining strategies for taking into account movements in asset prices is a perennially important issue for central banks. In this paper, an analysis is provided to address this issue for the U.S. economy. To do so, an empirical model of the U.S. economy is constructed and estimated, and the estimated model is simulated with a set of alternative monetary policy rules. Comparing the stabilization performance of the rules, it is found that: i ) by responding to a larger set of policy indicators and taking a more aggressive stance toward inflation and output gap in particular, the Federal Reserve could have achieved a much higher degree of stabilization; ii) had the Federal Reserve responded to its historical policy indicators differently, it could have conducted a near-optimal policy rule, even without taking into account movements in housing and stock prices; iii) the Federal Reserve could have likewise achieved close-to-optimal stabilization results by properly responding to movements in asset prices, on top of its historical policy scheme; and iv) stock price inflation contains more useful information that helps further stabilize the economy than does housing price inflation.

Keywords:

Asset prices, Stabilization, Monetary policy

Acknowledgments

The first author gratefully acknowledges the 2009 research grant from Hankuk University of Foreign Studies. The second author gratefully acknowledges the 2009 research grant from “SUAM FOUNDATION.”

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