Asset Price Learning and Optimal Monetary Policy

43 Pages Posted: 16 Nov 2017 Last revised: 1 Jun 2018

See all articles by Colin Caines

Colin Caines

Board of Governors of the Federal Reserve System

Fabian Winkler

Board of Governors of the Federal Reserve System

Multiple version iconThere are 2 versions of this paper

Date Written: May 25, 2018

Abstract

We characterize optimal monetary policy when agents are learning about endogenous asset prices. Boundedly rational expectations induce inefficient equilibrium asset price fluctuations which translate into inefficient aggregate demand fluctuations. We find that the optimal policy raises interest rates when expected capital gains, and the level of current asset prices, is high. The optimal policy does not eliminate deviations of asset prices from their fundamental value. When monetary policymakers are information-constrained, optimal policy can be reasonably approximated by simple interest rate rules that incorporate capital gains. Our results are robust to a wide range of belief specifications as well as to the inclusion of an investment channel.

Keywords: Optimal Monetary Policy, Natural Real Interest Rate, Learning, Asset Price Volatility

JEL Classification: E44, E52

Suggested Citation

Caines, Colin and Winkler, Fabian, Asset Price Learning and Optimal Monetary Policy (May 25, 2018). Available at SSRN: https://ssrn.com/abstract=3070761 or http://dx.doi.org/10.2139/ssrn.3070761

Colin Caines

Board of Governors of the Federal Reserve System ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States

Fabian Winkler (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

HOME PAGE: http://www.fabianwinkler.com

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