I develop a general equilibrium model with sticky prices, credit constraints, nominal loans and asset prices. Changes in asset prices modify agents ’ borrowing capacity through collateral value; changes in nominal prices affect real repayments through debt deflation. Monetary policy shocks move asset and nominal prices in the same direction, and are amplified and propagated over time. The “financial accelerator ” is not constant across shocks: nominal debt stabilises supply shocks, making the economy less volatile when the central bank controls the interest rate. I discuss the role of equity, debt indexation and household and firm leverage in the propagation mechanism. Finally, I find that monetary policy should not target asset prices as a means of reducing output and inflation volatility.

This paper analyzes the impact of unanticipated changes in the Federal funds target on equity prices, with the aim of both estimating the size of the typical reaction, and understanding the reasons for the market’s response. On average over the May 1989 to December 2001 sample, a “typical ” unanticipated 25 basis point rate cut has been associated with a 1.3 percent increase in the S&P 500 composite index. The estimated response varies considerably across industries, with the greatest sensitivity observed in cyclical industries like construction, and the smallest in mining and utilities. Very little of the market’s reaction can be attributed to policy’s effects on the real rate of interest or future dividends, however. Instead, most of the response of the current excess return on equities can be traced to policy’s impact on expected future excess returns. JEL codes: E44, G12. 1

One decade of inflation targeting in the world offers lessons on the design and implementation of inflation targeting, the conduct of monetary policy, and country performance under inflation targeting. This paper reviews briefly the main design features of 19 inflation targeting experiences, analyzes statistically if countries under inflation targeting are structurally different from non-inflation targeting industrial countries, and reviews existing evidence about the success of inflation targeting. The interaction of inflation targeting design features and the conduct of monetary policy during transition to low inflation are tackled next. The paper ends by focusing on unresolved issues on design and implementation of inflation targeting and their relation to the conduct of monetary policy – open issues that have to be addressed in the next decade of inflation targeting.

wish to thank Refet Gurkaynak for expert research assistance. The Japanese economy continues in a deep recession. The shortrange IMF forecast is that, as of the last quarter of 1999, Japanese real GDP will be 4.6 % below its potential. This number is itself a mild improvement over a year earlier, when the IMF estimated Japanese GDP at 5.6 % below potential. A case can be made, however, that these figures significantly underestimate the output losses created by the protracted slump. From the beginning of the 1980s through 1991Q4, a period during which Japanese real economic growth had already declined markedly from the heady days of the 1960s and 1970s, real GDP in Japan grew by nearly 3.8 % per year. In contrast, from 1991Q4 through 1999Q4 the rate of growth of real GDP was less than 0.9 % per year. If growth during the 1991-1999 period had been even 2.5 % per year, Japanese real GDP in 1999 would have been 13.6 % higher than the value actually attained. 1

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This paper examines what we have learned about monetary policy strategy and considers how we should change our thinking in this regard in the aftermath of the 2007-09 financial crisis. It starts with a discussion of where the science of monetary policy stood before the crisis and how central banks viewed monetary policy strategy. It then examines how the crisis has changed the thinking of both macro/monetary economists and central bankers. Finally, it looks at the extent to which the science of monetary policy needs to be altered and draws implications for monetary policy strategy.

Recent macroeconomic experience has drawn attention to the importance of interdependence among countries through financial markets and institutions, independently of traditional trade linkages. This paper develops a model of the international transmission of shocks due to interdependent portfolio holdings among leverage-constrained financial institutions. In the absence of leverage constraints, international portfolio diversification has no implications for macro-economic co-movements. When leverage constraints bind, however, the presence of diversified portfolios in combination with these constraints introduces a powerful financial transmission channel which results in a high correlation among macroeconomic aggregates during business cycle downturns, quite independent of the size of international trade linkages. Conversely, the paper shows that, conditional on leverage constraints binding, international financial integration through equity markets reverses the sign of the international co-movement of shocks, leading co-movement to switch from negative to positive.