MONETARY POLICY AND ASSET
PRICES: TO RESPOND OR NOT?
We investigate whether there is a case for asset prices in interest
rates rules within a
small econometric model of the Norwegian economy, modeling the interdependence
of the real
economy, credit and three classes of assets prices: housing prices, equity
prices and the nominal
exchange rate. We compare the performance of simple and efficient interest
rate rules that
allow for response to movements in asset prices to the performance of
more standard monetary
policy rules. We find that including housing prices and equity prices
in the policy rules can improve macroeconomic performance in terms
of both nominal and real economic stability. In contrast, a response to nominal exchange rate fluctuations can induce
excess volatility in general and prove detrimental to macroeconomic stability.