Learning, Central Bank Conservatism, and Stock Price Dynamics

Abstract This paper studies how adaptive learning affects the interactions between monetary policy, stock prices and the optimal degree of Rogoff conservatism in a New Keynesian DSGE model with non-Ricardian agents whose heterogeneous portfolios generate a financial wealth channel of monetary transmission. A positive intergenerational portfolio turnover in the stock market could improve the dual-mandate central bank’s intertemporal trade-off allowed by learning and implies a positive weight on financial stability in the social welfare criterion. For plausible learning gains and turnover rates, a rise in the turnover rate could lead the central bank to reduce the aggressiveness in its policy needed to manage private beliefs if the learning gain is high enough. Both the distortion due to learning and the central bank’s lack of concern for financial stability could lead the government to appoint a liberal central banker, i.e. less conservative than society. A rise in the turnover rate implies a higher (lower) degree of liberalism for low (high) learning gains.