Posted: September 13th, 2017

Should central banks use monetary policy to respond to asset prices?

Should central banks use monetary policy to respond to asset prices?

Paper details:
Instructions

1. Required readings are given but you need to extend beyond the given list. Aside from the required readings, you have to find 3 more readings to support your paper. You have to use google scholar to find these readings. The paper HAS to include ALL required readings plus the 3 extra readings that you find yourself.

2. Your paper must cite sources in the usual format in economics: a work discussed in the text is cited as (Taylor 2010) and again in the bibliography where a full reference is given. Your bibliography must be placed in the end pages of the paper, after the main text of your paper, but before any graphs, tables, diagrams and so on. Important: there must be a one-to-one correspondence between works discussed in your paper and works listed in ?the bibliography; that means every work in the bibliography must be discussed in the paper and every work cited in the paper must be listed in the bibliography.

3. Format: at least 4 pages and at most 6 pages (not counting the end pages), double-spaced with 1-inch margins and 12-point Times New Roman font. Your paper should start with a title page (unnumbered) that includes the paper topic and your name only. The text of your paper begins on the next page, labeled page one; all subsequent pages are numbered. After the last page of writing comes the bibliography; after the bibliography you may have additional pages of figures, graphs, tables and so on but only if they are discussed in your paper. There must be a one-to-one correspondence between figures, graphs, tables, diagrams and so on discussed in your paper and those included in the end pages. Figures, graphs and so on must be numbered sequentially as they appear in your paper so that the first graph you refer to in your paper is labeled as figure 1, the second figure you refer to in your paper is labeled as figure 2 and so on. The title page and end pages (bibliography, tables, graphs, diagrams and so on) do not count toward the page limit.

4. While your paper must assess the pros and cons of the policy question, you must take a stand on the issue. Your paper must explain why you are taking this stand and must defend it. The first paragraph of your paper must contain a statement on your position.

5. Write your paper for your smartest classmate, who, you may assume, knows the content of this course. Thus our course material should not be discussed in your paper. Anything that is new to you on this topic will be new to your classmate and should be discussed. Assume your smart classmate knows intermediate microeconomics and macroeconomics and is familiar with regressions and other basic statistical tools.

6. Your paper must be free of spelling and grammatical errors; it must be written clearly and must be well organized. The quality of your writing forms part of your grade. Every
paper receives two grades: the first for the quality of the economic analysis; the second, for the quality of writing and for following the directions.

TOPIC

Should central banks use monetary policy to respond to asset prices?

One recommendation for monetary policy is that it be conducted through an interest rate rule that responds to output and inflation. For example, an interest rate rule may be of the form i = i(Y, p), where the two partials of i = i(Y, p) are positive, meaning the central bank sets a higher nominal interest rate when either output or inflation increases above a target level. John Taylor argues that this is a good way to conduct policy and this rule has come to be known as a Taylor rule.

This topic asks you to address the suggestion that the central bank use monetary policy to also respond to rapidly rising asset prices (called by some “asset price bubbles”), in addition to the traditional output and inflation in the Taylor rule. Put another way, the proposal is that for a given level of output and inflation, the central should aim for a higher level of the policy interest rate when the prices of stocks and houses are higher. Your essay should critically evaluate this proposal and make a recommendation concerning whether it should be adopted.

REQUIRED READINGS

Kevin J. Lansing, “Monetary Policy and Asset Prices.” Federal Reserve Bank of San Francisco Economic Letter Number 2008-34 (October 31, 2008). http://www.frbsf.org/publications/economics/letter/2008/el2008-34.pdf.

Ben S. Bernanke, “Asset-Price ‘Bubbles’ and Monetary Policy,” speech at the New York Chapter of the National Association for Business Economics, New York, New York, October 15, 2002. http://www.federalreserve.gov/boarddocs/speeches/2002/20021015/default.htm.

Donald L. Kohn, “Monetary Policy and Asset Prices Revisited, Cato Journal 29 (Winter 2009): 31-44. http://www.cato.org/pubs/journal/cj29n1/cj29n1-4.pdf.

Alan Greenspan, “Risk and Uncertainty in Monetary Policy,” American Economic Review 94 (May 2004): 33–40. http://www.jstor.org/stable/pdfplus/3592853.pdf?acceptTC=true.

Claudio Borio and Philip Lowe, “Asset Prices, Financial and Monetary Stability: Exploring the Nexus,” Bank for International Settlements Working Paper 114 (July 2002). http://www.bis.org/publ/work114.htm.

William R. White, “Should Monetary Policy ‘Lean or Clean’?” Federal Reserve Bank of Dallas Globalization and Monetary Policy Institute. Working Paper No. 34 (2009). http://www.dallasfed.org/institute/wpapers/2009/0034.pdf

Stephen G. Cecchetti, Hans Genberg, and Sushil Wadhwani, “Asset Prices in a Flexible Inflation Target Framework,” National Bureau of Economic Research Working Paper 8970 (2002). www.nber.org/papers/w8970.pdf.

Ben Bernanke and Mark Gertler, “Monetary Policy and Asset Price Volatility” in New Challenges for Monetary Policy (Kansas City: Federal Reserve Bank of Kansas City, 1999), 77- 128. http://www.kansascityfed.org/publicat/sympos/1999/S99gert.pdf.

Jeremy Stein, (2013) Overheating in Credit Markets: Origins, Measurement, and Policy Responses, Speech, Feb 7, 2013. http://www.federalreserve.gov/newsevents/speech/stein20130207a.pdf