Asset Price Misalignments And Monetary Policy Implementations

During the post financial crisis era, China, amongst other emerging market economies,is faced with balancing the processes of suppressing asset price bubbles, deleveraging, andeliminating excess capacity, and all of which are now constraining China’s potential growthon the one hand, and restricting policy implementations on the other. In recent decades, assetmarkets have played an increasingly important role in many economies, and fluctuations inasset prices have become a relevant issue for policy makers. Basically, asset price stability andgeneral price stability are two major objectives for central banks. In other words, dealing withasset misalignments means monetary authorities should balance the importance of financialstability and long-term price stability in the short run. And this issue attracts massive debatesafter the subprime crisis. Therefore, in virtue of modern monetary and financial theory, thisthesis starts from China’s reality in order to inquiry into this spot and to offer relevant policysuggestions.As it known to all, most market mispricing can be resolved under market mechanism.In order to explore when monetary policy should rectify mispricing which has great impactson economy afterwards, we must identify asset price misalignments that have these kind ofimportant implications. As for this, we can examine the existence of speculative bubbles atstock market vis-a`-vis housing market as the first step.By employing daily closing data of CSI300and CSI300Total Return from April,2006to September,2012, we first identifies and analyzes the speculative bubbles in China’sstock market by employing state-space model with Markov-switching approach derived fromCampbell and Shiller’s dividend-price ratio model. Results show that there is a significantspeculative bubble process in China’s stock market, and it evolves with two distinct regimes:the surviving and collapsing states. The4most significant bubble collapsing periods hap-pened in Nov.2006, Jun.2007, Feb.2008, and Aug.2009, and the bubble risk vanishedalong with the collapsing process. As for the investors and policy makers, the quantifica-tion results yield by our approach can be conducive to conducting the risk managements andformulating timely policies.As for housing markets, this dissertation applies Homm and Breitung (2012) Supreme ADF tests since direct pricing for real estates is rather difficult. Here, we use the rollingsample SADF test combined with real-time monitoring to examine the existence of asset pricebubbles in China’s housing markets indirectly. In the meantime, we classify different phasesof speculative bubbles. As indicated in the empirical results, there are significant bubbleprocess in China’s housing markets, there are2bubble bursts during the sample period, onesstarts from May,2004and the other happens during financial crisis. Based on the methoddeveloped in this chapter we can construct an applicable housing bubble detecting framework.Conditioning on the existence of speculative bubbles, we generalize the asset price bub-ble issue to the asset price misalignment framework, and delve into the problem that what isthe level of misalignment that monetary authority may be concerned. We use the generalizedadditive quantile regression model to compute the conditional distributions for stock priceand housing price and identifies busts and booms over the20%and80%quantiles. Empiri-cal results show that the housing price has high volatility frequency but low volatility range,most owning to the urbanization process and high regulated housing markets. To the contrary,there are few stock market misalignments, but high volatility range. By comparing the datesof misalignments happened in these two markets, there are comovements and the reversesfor stock price misalignments. With reference to monetary policy regimes, we can see thatwhen the stance of monetary authorities doesn’t change too much, the capital flows betweenthese two markets are possible explanations for the reverse movement of price misalignments.Moreover, we use discrete choice model to detect the linkage between monetary factors andasset price misalignments. As it is indicated in the empirical results, excess liquidity factors,inter alia, can explain the phases of asset price booms.After identifications of booms and busts of asset prices, we further explore the issuethat what kind of monetary policy implementations should be used in response to asset pricemisalignments.By augmenting the standard New Keynesian Monetary Model with heterogeneoustraders, this thesis calibrates and evaluates the effects of monetary policy which respondsto asset price misalignments. In the first place, the simulation results show that proactive pol-icy is the suboptimum choice for monetary authorities when they cannot grasp the exact stateof stock market. Moreover, by considering the asset price misalignments and systematicallyresponse to it with interest rules, the economic system can achieve the determinate and sta-ble rational expectations equilibrium much easier with more flexible response coefficient forinflation and output gaps.Turn to the housing market, we construct a dynamic equilibrium model and exploresthe underlying mechanism that how money supply can affect housing price through the chan-nel of demand both from the empirical and theoretical perspectives. The results validate theeffectiveness of monetary policy on regulating housing markets. However, monetary policycan be more effective under lower demand in the market and through the channel of increas-ing the returns of other assets. The policy implications derived from our paper stress that financial policy should cooperate with fiscal and taxation policies to expel speculative and in-vestment demand. Under the guidance of a clear macro-control target, policy makers shouldpay attention to manage house buyers’ expectation, and try to create other investment con-duits to squeeze out excessive investment or even speculation demand in the housing market.Last but not least, monetary authorities should pay more attention to the potential effects ofpricking housing bubble policies on the stabilities of aggregate output and macroeconomicstability since the real estate industry have very close associativity with other industries, likeconstructing industry, leasing and business services, and the pivotal one to financial stability,i.e. the banking system.To sum up, we conclude that asset price misalignments can be rectified via proper mon-etary policy implementations. Meanwhile, monetary authorities should pay attention to theimplication of asset price volatility when conducting macro-control. Via screening and judg-ing the situation of asset price booms and busts, central banks should response to asset pricemisalignments systematically with a proactive policy regime.