This thesis will investigate the role of asset prices, in particular stock prices, on monetary policy in Norway. There has been a long established consensus in the literature that asset prices should not be targeted explicitly, mainly due to the uncertainty surrounding the identification of asset price misalignments and the uncertain effects interventions may have on asset markets. However, recent contributions in the literature have argued that asset prices might have a more prominent role due to, among others, their forward-looking nature. This thesis will survey some of these contributions and perform an empirical investigation on interest rate rules and asset prices using Norwegian data.
Asset prices could be included in empirically estimated interest rate rules (reaction functions) provided that the simultaneity issue between asset prices and interest rates, and the measurement problem are appropriately addressed. Using Norwegian data I find that asset prices enter significantly in a simultaneous model estimated using two stage least squares (2SLS). I also find that asset prices contain more precise information on future inflation than the output gap and the growth gap, particularly in conjunction with the unemployment gap. This implies that asset prices can be viewed as an alternative real-time variable to the output gap or alike.