Monetary policy, asset prices and the wealth channel

A counterfactual analysis of the United Kingdom economy

Bachelor Thesis , 2010 , 53 Pages , Grade: 5.75 von 6

Economics - Case Scenarios

This thesis examines whether monetary policy in the United Kingdom during the last 15 years should have reacted more strongly to asset price misalignments in financial assets and real estate assets, and if it should have reacted with different magnitude to the two asset classes. A counterfactual analysis using a dynamic structural general equilibrium (DSGE) model is conducted to test several scenarios, as well as to derive the optimal parameter set by exposing the model to shocks derived from historical data. It concludes that a more proactive monetary policy would have been preferable in the past, and that monetary policy should have reacted more to misalignments in real estate prices than in financial asset prices. Reacting to asset prices in general is found to be optimal in the random case.

Table of contents

1 Introduction

2 Asset prices and their effects on the real economy
2.1 Asset prices and asset bubbles
2.2 Effects on the real economy
2.2.1 Wealth channel
2.2.2 Liquidity channel
2.3 Arguments pro and contra monetary action

3 Counterfactual analysis
3.1 Basic model
3.2 Asset prices model
3.3 Methodology
3.4 Dataset
3.5 Parameter estimates
3.6 Impulse response tests

4 Results
4.1 Loss function
4.2 Baseline results compared with reaction to asset prices
4.3 Optimal policy parameters
4.4 Robustness tests
4.4.1 Different baseline error terms
4.4.2 Random shocks
4.4.3 Different magnitude of the wealth channel

5 Conclusion

References

Appendix A: Graphs and statistics

Appendix B: MATLAB code

• College: University of St. Gallen
• Grade: 5.75 von 6
• Author: Jonathan Horlacher (Author)
• Year: 2010
• Pages: 53
• Catalog Number: V179138
• ISBN (eBook): 9783656015437
• ISBN (Book): 9783656015130
• Language: English
• Tags: Blasen, Wohlstandskanal, DSGE Modell, Geldpolitik, makroökonomie, monetary policy, wealth channel, macroeconomics, speculative bubbles, Bank of England