Fluctuations In Asset Prices And Monetary Policy Options

Since the end of 20th century, the world economy and international financial situation has changed dramatically, the economic volatility emerged in many countries when their interest rates, prices and domestic real economies remained relatively stable. Such as Japan's economic slump in 1980s caused by the bursting of the "bubble economy", the Asian financial crisis in the late 1990s, especially in Western countries like the United States, the asset prices significantly deviated from the real economy and led to the financial crisis in 2007 and eventually led to the global economic crisis. Just as Bernanke (1999) asserts:"In the past two decades, the world's major central banks were largely successful in control of inflation. Although it's too early to ignore inflation, it can be expected that the future of the central bankers' main battle will be in another battleground. There is an important phenomenon that has attracted the attention of policymakers, that is, the instability of the financial system is significantly increased, an important part of which is asset price volatility."There are great differences and disputes domestically and internationally on "the central bank to respond to asset price volatility". The most famous argument is the dispute between Bernanke (1999) and Cecchetti (2000). The focus of their debate is the distinction between the causes of asset price bubbles, as well as even if the asset price bubble can be recognized, monetary policy may not be an effective tool to suppress the bubble. Faced up with the volatility in stock prices in 2008, China had the debate on whether the government should rescue the stock or not; with the soaring real estate prices, Chinese government has conducted three rounds of large-scale regulation on real estate prices since 2010.The Central Bank should take asset prices into the objective function of monetary policy or not needs to address the following questions:Firstly, if there is a significant correlation between the asset prices and the intermediate targets ofmonetary policy, such as interest rates, money supply, and other macroeconomic variables such as inflation, output growth? Secondly, whether asset prices are already affecting the development of real economy? Thirdly, if the Central Bank takes asset prices into monetary policy objective function, which is helpful to reduce the inflation gap and output gap, and what is the benefits and loss? Fourthly, whether the Central Banks has the ability of identifying and successfully controlling asset price bubbles?After the analysis and research, there are some conclusions as follow:First, there is a long-term cointegration relationship and significant correlation between China's real estate prices, stock prices and interest rates, money supply, CPI, GDP. The asset price volatility not only indicates the inflation but also impacts the output growth. However, the interest rate and the money supply does not respond to asset price fluctuations. Second, the monetary policy influences on the real economy through the transmission mechanism of asset prices, mainly including the consumption effect on the residents, business balance sheet effects, household effects and other forms of liquidity. In focusing on the inspection of consumption effect of real estate wealth, we take conclusions that our overall short-term consumption of real estate wealth effect was 0.11, and the long-term consumption effect was 0.29, which meaning China's real estate price fluctuations can affect the people's consumption, thus acts on the real economy. Third, through formatting dynamic stochastic general equilibrium model (DSGE), we simulation analysis the benefits and costs by considering the asset prices into the interest rate rule function and not, we found that the central bank to asset prices into monetary policy conducive to the objective function reduce the inflation gap and output gap, especially when it has enough information asset price fluctuations,therefore, the central bank has sufficient reasons to take the asset price fluctuations into its monetary policy objective function. Last, in order to identify and control the asset price bubble, the central bank should setup an generalized price index including asset prices, and strengthen the ability to cellecting and recognizing the information of asset prices fluctuations, which need to increase central bank independence and transparency and set up a special department of regulating the asset price volatility. Monetary policy should coordinate with the financial regulatory policy and the fiscal policy. In order to reducing the probability of asset price bubble burst and reducing the negative impacts on the real economy after the bubble burst, the central bank also need build a prudential macroeconomic policy framework which containing the monetary policy and financial regulation policy.