Optimal Monetary Policy and Rational Asset Bubbles

47 Pages Posted: 29 Aug 2023 Last revised: 30 Aug 2023

See all articles by Jacopo Bonchi

Jacopo Bonchi

Università degli Studi di Milano-Bicocca - Department of Economics, Management and Statistics (DEMS)

Salvatore Nisticò

Sapienza University - Department of Social Science and Economics

Date Written: August 28, 2023

Abstract

Using a New Keynesian model with stochastic asset market participation, we analyze the normative implications of bubbly fluctuations for monetary policy. We show that stochastic asset-market participation allows rational bubbles to emerge in equilibrium despite the fact that households are infinitely lived. A central bank concerned with social welfare faces an additional tradeoff implied by the effect of bubbly fluctuations on consumption dispersion across market participants, which makes, in general, strict inflation targeting a suboptimal monetary-policy regime. Deviations from inflation targeting are welfare improving in particular when the economy fluctuates around a balanced-growth path where equilibrium bubbles are small or absent, and the endogenous tradeoff is more stringent, requiring larger deviations of inflation/output gap to mitigate bubbly fluctuations in wealth and thus consumption inequality. The specific optimal monetary-policy response to bubbly fluctuations depends however on the intrinsic features of latter, and the associated effects on wealth inequality.

Keywords: Rational bubbles, Optimal monetary policy, Stochastic Asset Market Participation, Consumption dispersion

JEL Classification: E21, E32, E44, E58

Suggested Citation

Bonchi, Jacopo and Nisticò, Salvatore, Optimal Monetary Policy and Rational Asset Bubbles (August 28, 2023). University of Milan Bicocca Department of Economics, Management and Statistics Working Paper No. 525, Available at SSRN: https://ssrn.com/abstract=4532927 or http://dx.doi.org/10.2139/ssrn.4532927

Jacopo Bonchi (Contact Author)

Università degli Studi di Milano-Bicocca - Department of Economics, Management and Statistics (DEMS) ( email )

Piazza dell'Ateneo Nuovo, 1
Milan, 20126
Italy

Salvatore Nisticò

Sapienza University - Department of Social Science and Economics ( email )

Piazzale Aldo Moro 5
Rome, 00185
Italy

HOME PAGE: http://sites.google.com/view/salvatore-nistico

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