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
Date Written: July 2001
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: Suggested Citation