News libri - The implementation of monetary policy and financial markets volatility: an evolving relationship

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The implementation of monetary policy and financial markets volatility: an evolving relationship.

Edizioni CNR-Issm

 

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The developments in asset markets have influenced researchers to focus on the interaction between monetary policy and the financial system. The aim of this research is twofold; firstly, we want to investigate the importance of asset market shocks for the real economy and if the use of asset price movements for the central banks can improve macroeconomic stability. We provide an overview of the role of the financial system for the whole economy. We discuss policy credibility, time– inconsistency, and commitments, and then make a survey of policy coordination literature. We also present a brief description of the conduct of the European Central Bank’s monetary policy. We show the importance of the financial sector in transmitting the monetary policy actions. We also construct a model of a policy game in order to analyse the optimal reaction function of the Central Bank to a shock in the asset market. In doing so, we consider a cooperative game and three different non-cooperative games: Nash equilibrium, Stackelberg equilibria (with an accommodate and conservative central bank respectively and different games in which we assume that both central banks react to a shock in their asset markets. Finally, we address the following issues: 1) the importance of the Financial Condition Index (FCI hereafter) in explaining a potential misalignment in asset markets; 2) the use of the FCI as an important short term indicator to guide the conduct of monetary policy. Moreover, we explore the possibility of a non-linear relationship between EMU stock returns and ECB’s monetary policy innovations. The non-linearity is modelled using different Markov-switching (MS) regime autoregressive models. We investigate the empirical performance of the univariate MS models used to describe the switches between different economic regimes for the 11 EMU countries’ stock markets and, furthermore, extending these models to test if the inclusion of monetary policy shock as an exogenous variable provides a more accurate identification of the switches between different economic phases.