According to empirical evidence brought in by this paper, the Fed seems to respond stronger to positive than to negative deviations in inflation from trend, it also presents an asymmetric response with respect to asset prices. We provide a theoretical explanation that builds on the methodology developed by Romaniuk (2008) for a central banker with two main goals, output and price stability. In this paper, the policymaker behaves as a portfolio manager who aims at stabilizing output, goods prices, as well as asset prices. An optimal, time-varying interest rate rule is obtained as the Merton’s (1971) continuous time solution to the portfolio manager’s problem. In a second step, option terms are included in the interest rate rule, in order to allow the central bank to react differently to positive and negative deviations of key variables from their targets.
ROMANIUK, K. et VRANCEANU, R. (2008). Asset Prices and Asymmetries in the Fed’s Interst Rate Rule: A Financial Approach. ESSEC Business School.