Why the Fed Should Ignore the Stock Market

By James Bullard, E. Schaling. 2002

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James B. Bullard and Eric Schaling study a simple, small dynamic economy which a policymaker is attempting to control with a Taylor-type monetary policy rule. The authors wish to understand the macroeconomic consequences of the policymaker’s decision to include the level of equity prices in the rule. They show that such a policy can be counterproductive because it can interfere directly with the policymaker’s ability to minimize inflation and output variability. In extreme cases, a policy of targeting equity prices can lead to an indeterminate rational expectations equilibrium and hence a more unpredictable form of volatility than would be achieved by maintaining a rule without asset prices included. They thus provide an important and novel theoretical reason why policymakers may wish to ignore equity market developments when setting monetary policy.

Subfields: Economics and Econometrics

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