ASSET PRICES,OUTPUT AND MONETARY POLICY IN A SMALL OPEN ECONOMY

We formulate a macro‐model of a small open economy in order to investigate the relative performance of rules that respond to asset prices and those that do not. Our model consists of three asset prices: the stock price, the long‐term interest rate and the exchange rate. These asset prices interact with nominal wage and price Phillips curves, a law of motion for the labour share, a dynamic IS curve that describes output adjustment and a Taylor‐type interest rate policy rule. Estimations of the model show that policy rules that respond to asset price movements dominate rules that do not.