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)| false Jinushi, Toshiki, Yoshihiro Kuroki, and Ryuzo Miyao, 2000, “Monetary Policy in Japan Since the Late 1980s: Delayed Policy Actions and Some Explanations,”in Japan’s Financial Crisis and Its Parallels to U.S. Experience, ed.by Institute for International Economics, Ryoichi Mikitaniand Adam Posen, Special Report, Vol. 13, pp. 115– 48.
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For an extensive discussion of the issues related to the role of asset prices in designing macroeconomic policy, see the International Monetary Fund’s World Economic Outlook (May 2000, Chapter 3, “Asset Prices and the Business Cycle”).
This rule can also be obtained in a framework where the central bank faces a quadratic loss function over inflation and output (Svensson, 1997; Bernanke and Woodford, 1997, and the references therein).
The ex ante real interest rate can be obtained as
We decided to use this sample period because, as documented in previous contributions, there is evidence of structural instability in monetary policy reaction functions when using pre-1979 data (Clarida, Galí, and Gertler, 1998).
For further details, see the relevant discussion in Galí, Gertler, and López-Salido (2001), which we followed closely in the construction of our time series.
A robustness exercise was carried out using measures based on the S&P 500 index for the United States, the FTSE100 index for the United Kingdom, and the NIKKEI 225 index for Japan (see “Robustness” in Section III).
As discussed in our “Robustness” section below, these findings hold up when using different measures of asset prices disequilibria.
We also executed the same robustness exercise using the S&P 500, FTSE100, and NIKKEI 225 indices for the United States, the United Kingdom, and Japan, respectively, over a shorter sample period (because of data availability). In addition, we checked whether having asset prices and exchange rates enter the augmented policy rule contemporaneously made a difference. The results, not reported, are qualitatively and quantitatively similar to the ones reported in Tables 2 and 3.
Our interpretation that the reaction of central banks to asset price and exchange rate disequilibria may depend on the size of the disequilibria themselves suggests that a nonlinear characterization of interest rate rules may be a logical extension of our research. The possibility of a nonlinear reaction function can also be rationalized on the theoretical work of Bordo and Jeanne (2002) and is indeed suggested by the earlier work on escape clauses of Flood and Isard (1989). However, a nonlinear generalization is not straightforward in this context since the reaction function would be partly linear—in expected inflation and output gap—and partly nonlinear—in asset prices and exchange rates. To the best of the authors’ knowledge, no GMM or instrumental variables estimator exists to date for models of this kind (or indeed for any multivariate threshold model), which makes estimation and statistical inference especially cumbersome in this context.