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Monetary Policy Rules, Asset Prices, and Exchange Rates Jagjit S. Chadha, Lucio Sarno, and Giorgio Valente Full Text of this Article (PDF 237K) We examine empirically whether asset prices and exchange rates may be admitted into a standard interest rate rule, using data for the United States, the United Kingdom, and Japan since 1979. Asset prices and exchange rates can be employed as information variables for a standard “Taylor-type” rule or as arguments in an augmented interest rate rule. Our empirical evidence, based on measures of the output gap proxied by marginal cost calculations, suggests that monetary policymakers may use asset prices and exchange rates not only as part of their information set for setting interest rates, but also to set interest rates to offset deviations of asset prices or exchange rates from their equilibrium levels. These results are open to several alternative interpretations. [JEL E40, E44, E52, E58] |