Rethinking Monetary Stabilization in the Presence of an Asset Bubble

GLOBAL DIVERGENCE IN TRADE, MONEY AND POLICY, Volbert Alexander and Hans-Helmut Kotz, eds., pp. 172-191, Edward Elgar Publishing, Cheltenham, United Kingdom, 2006

40 Pages Posted: 19 Oct 2007 Last revised: 18 Jan 2008

See all articles by Marc D. Hayford

Marc D. Hayford

Loyola University of Chicago - Department of Economics

A. (Tassos) G. Malliaris

Loyola University of Chicago - Department of Economics

Abstract

This paper addresses three important questions: how should monetary policy respond to stock market booms, what causes stock market bubbles and can monetary policy pop them. These questions arose during the recent stock market bubble during 1995-2000 and its collapse during 2000-1. To answer these questions we rapidly review the lessons learned from the Fed's response to the stock market boom in the 1920s and the lessons learned from the response of the Bank of Japan in the 1990s. The conclusion of the paper is that an asymmetric response of monetary policy to the stock market booms is appropriate: neutral in stock market booms unless they cause inflation, monetary ease after a stock market bust to dampen the effect on output and if necessary to provide liquidity to the financial system. The theoretical bubble literature and the U.S. experience in the 1920s provides little evidence that monetary policy can pop bubbles and attempting do so is potentially costly in terms of lost output.

Keywords: Rethinking, monetary, stabilization, asset, bubble

Suggested Citation

Hayford, Marc D. and Malliaris, A. (Tassos) G., Rethinking Monetary Stabilization in the Presence of an Asset Bubble. GLOBAL DIVERGENCE IN TRADE, MONEY AND POLICY, Volbert Alexander and Hans-Helmut Kotz, eds., pp. 172-191, Edward Elgar Publishing, Cheltenham, United Kingdom, 2006. Available at SSRN: https://ssrn.com/abstract=1021805 or http://dx.doi.org/10.2139/ssrn.1021805

Marc D. Hayford

Loyola University of Chicago - Department of Economics ( email )

820 N. Michigan Ave.
Chicago, IL 60611
United States
312-915-6062 (Phone)
312-915-8508 (Fax)

A. (Tassos) G. Malliaris (Contact Author)

Loyola University of Chicago - Department of Economics ( email )

16 E. Pearson Ave
Quinlan School of Business
Chicago, IL 60611
United States
312-915-6063 (Phone)

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