Asymmetric monetary policy towards the stock market: A DSGE approach

In the aftermath of the financial crisis, it has been argued that a guideline for the design of the future policy framework should be to take the ‘a’ out of ‘asymmetry’ in thewaymonetary policy deals with asset pricemovements. Recent empirical evidence has suggested that the Federal Reserve may have followed an asymmetric policy towards the stock market in the precrisis period. According to these findings,monetary policy in theUS before the crisis involved a reaction to stock price drops, but no reaction to increasing stock prices. The present paper studies the effects of such apolicy in aDSGEmodel. The asymmetric policy rule introduces an important non-linearity into the model: Booms in output and inflation tend to be amplified, while recessions are dampened. Moreover, such a policy gives rise to expectations-driven booms in asset prices.We further investigate towhat extent an asymmetric stock price reaction could bemotivated by the desire of policymakers to correct for inherent asymmetries in the way stock price movements affect the macroeconomy. 2013 Elsevier Inc. All rights reserved.