Monetary policy, asset markets and business cycles : An assesment of Haavelmo's short-run macroeconomic model

Abstract

The model of portfolio management presented in Haavelmo (1969) is the point of departure for this thesis, presented in chapter 2. This model introduces a fundamental link between asset markets and the real economy by allowing real capital to serve the role of both an asset and a factor of production. This link makes the model suitable for representing the fragility of the real economy to imbalances in asset markets. In particular, the model introduces the following paradox: Any attempt to control interest rates in order to achieve a monetary goal such as stabilization of CPI inflation may disrupt the equilibrium of asset markets, and in that way lead to changes in macroeconomic relationships that may be difficult to chart in real time. Thereby “predictability” of the macroeconomy, which is essential as an aid to policy decisions, may be lost.