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Do Asset Price Developments Matter? Evidence for the United States and the Euro Area

There is an open debate about the role of asset prices in the conduct of monetary policy. The current crises and the burst of housing bubble give occasion to revisit this question. We present Generalized Method of Moments (GMM) estimates of the Taylor rule by using its classic version (Taylor, 1993), together with an augmented one with a proxy for asset price developments. We use data spanning from 1999:01 to 2009:06, for the United States and the Euro Area. Our estimations suggest three important results. The Taylor principle is respected when we estimate Taylor rules with output gap and inflation. The Fed seems react to developments in the financial sector, while there is no response to stock price movements by the ECB. Finally, Fed’s response to an asset price boom varies from 100 to 300 basis points, indicating a striking reaction against asset price developments.