Should Monetary Policy Respond to Asset Price Bubbles? Some Experimental Results

FRB of Kansas City Working Paper No. 01-04

33 Pages Posted: 2 Oct 2001

See all articles by Andrew J. Filardo

Andrew J. Filardo

Bank for International Settlements (BIS) - Monetary and Economic Department

Date Written: July 2001

Abstract

Should central banks respond to asset price bubbles? This paper explores this monetary policy question in a hypothetical economy subject to asset price bubbles. Despite the highly stylized structure of the model, the results reveal several practical monetary policy lessons. First, a monetary authority should generally respond to asset prices as long as asset prices contain reliable information about inflation and output. Second, this finding holds even if a monetary authority cannot distinguish between fundamental and bubble asset price behavior. Third, a monetary authority's desire to respond to asset prices falls dramatically as its preference to smooth interest rates rises. Finally, a monetary authority should not respond to asset prices if there is considerable uncertainty about the macroeconomic role of asset prices.

Keywords: Monetary Policy, Asset Prices

JEL Classification: E5, G1

Suggested Citation

Filardo, Andrew J., Should Monetary Policy Respond to Asset Price Bubbles? Some Experimental Results (July 2001). FRB of Kansas City Working Paper No. 01-04. Available at SSRN: https://ssrn.com/abstract=285413 or http://dx.doi.org/10.2139/ssrn.285413

Andrew J. Filardo (Contact Author)

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

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