Monetary Policy and Rational Asset Price Bubbles

54 Pages Posted: 16 Feb 2013

See all articles by Jordi Galí

Jordi Galí

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI); Massachusetts Institute of Technology (MIT) - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

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Date Written: February 2013

Abstract

I examine the impact of alternative monetary policy rules on a rational asset price bubble, through the lens of an overlapping generations model with nominal rigidities. A systematic increase in interest rates in response to a growing bubble is shown to enhance the fluctuations in the latter, through its positive effect on bubble growth. The optimal monetary policy seeks to strike a balance between stabilization of the bubble and stabilization of aggregate demand. The paper's main findings call into question the theoretical foundations of the case for "leaning against the wind" monetary policies.

Suggested Citation

Gali, Jordi, Monetary Policy and Rational Asset Price Bubbles (February 2013). NBER Working Paper No. w18806, Available at SSRN: https://ssrn.com/abstract=2219065

Jordi Gali (Contact Author)

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI) ( email )

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Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

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Centre for Economic Policy Research (CEPR)

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National Bureau of Economic Research (NBER)

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