Monetary Policy and Asset Price Gap Signal Technology in a New Keynesian Framework

Abstract

This article develops a New Keynesian model in which the inflation rate depends on the present value of future output gaps and asset prices gaps. The latter follows a price adjustment process. These asset price gaps are driven by 'asset price gap signal technology', a measure of exponentially distributed asset price gaps with a signalling mechanism. Within a dynamic stochastic optimisation approach, I identify a policy rule for the central bank in which the asset price gap the difference between the actual asset price at time t to its fundamental value plays a crucial role in determining the nominal rate of interest.