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Ensuring Financial Stability: Financial Structure and the Impact of Monetary Policy on Asset Prices

This paper studies the responses of residential property and equity prices, inflation and economic activity to monetary policy shocks in 17 countries, using data spanning 1986-2006. We estimate VARs for individual economies and panel VARs in which we distinguish between groups of countries on the basis of the characteristics of their financial systems. The results suggest that using monetary policy to offset asset price movements in order to guard against financial instability may have large effects on economic activity. Furthermore, while financial structure influences the impact of policy on asset prices, its importance appears limited | Revised draft Ensuring Financial Stability Financial Structure and the Impact of Monetary Policy on Asset Prices Katrin Assenmacher-Wesche Research Department Swiss National Bank Stefan Gerlach Institute for Monetary and Financial Stability Johann Wolfgang Goethe University Frankfurt March 26 2008 Abstract This paper studies the responses of residential property and equity prices inflation and economic activity to monetary policy shocks in 17 countries using data spanning 1986-2006. We estimate VARs for individual economies and panel VARs in which we distinguish between groups of countries on the basis of the characteristics of their financial systems. The results suggest that using monetary policy to offset asset price movements in order to guard against financial instability may have large effects on economic activity. Furthermore while financial structure influences the impact of policy on asset prices its importance appears limited. Keywords asset prices monetary policy panel VAR. JEL Number C23 E52 The views expressed are solely our own and are not necessarily shared by the SNB. We are grateful to seminar participants at the SNB and Petra Gerlach for helpful comments. Contact information Katrin Assenmacher-Wesche corresponding author SNB Börsenstrasse 15 Postfach 2800 CH-8022 Zürich Switzerland Tel 41 44 631 3824 email Katrin.Assenmacher-Wesche@snb.ch Stefan Gerlach IMFS Room 101D Mertonstrasse 17 D-60325 Frankfurt Main Germany email Stefan.Gerlach@wiwi.uni-frankfurt.de. 1. Introduction There is much agreement that asset prices in particular residential property prices provide a crucial link through which adverse macroeconomic developments can cause financial instability.1 Episodes of asset price booms are seen as raising the risk of a sharp correction of prices which could have immediate repercussions on the stability of financial institutions. Indeed many observers have argued that property-price collapses have historically played an important role in .