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Asset Prices and Monetary Policy: A Canadian Perspective on the Issues

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    Abstract

    The issue addressed in this article is the extent to which monetary policy in Canada should respond to asset-price bubbles. The article concludes that maintaining low and stable consumer price inflation is the best contribution that monetary policy can make to promoting economic and financial stability, even when the economy experiences asset-price bubbles. In extreme circumstances--when an asset-price bubble is well identified and likely to have significant costs to the economy when it bursts--monetary policy might better maintain low and stable consumer price inflation by leaning against a particular bubble even though it may mean that inflation deviates temporarily from its target. Such a strategy might reduce the risk that a crash in asset prices could lead to a recession and to inflation markedly below target in the longer run. The circumstances where this strategy is possible will be rare because economists are far from being able to determine consistently and reliably when leaning against a particular bubble is likely to do more harm than good. Housing-price bubbles should be a greater concern for Canadian monetary policy than equity-price bubbles, since rising housing prices are more likely to reflect excessively easy domestic credit conditions than are equity prices, which are largely determined in global markets.

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    Bibliographic Info

    Article provided by Bank of Canada in its journal Bank of Canada Review.

    Volume (Year): 2004 (2004)
    Issue (Month): Autumn ()
    Pages: 3-14

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    Handle: RePEc:bca:bcarev:v:2004:y:2004:i:autumn04:p:3-14

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    Cited by:
    1. Frederic S. Mishkin, 2007. "Housing and the monetary transmission mechanism," Finance and Economics Discussion Series 2007-40, Board of Governors of the Federal Reserve System (U.S.).
    2. Alan G. Ahearne & John Ammer & Brian M. Doyle & Linda S. Kole & Robert F. Martin, 2005. "Monetary Policy and House Prices: A Cross-Country Study," Working Papers Central Bank of Chile 344, Central Bank of Chile.
    3. Martha López, 2005. "House Prices and Monetary Policy in Colombia," Working Papers Central Bank of Chile 349, Central Bank of Chile.
    4. Frederic S. Mishkin, 2011. "Monetary Policy Strategy: Lessons From The Crisis," Chapters, European Central Bank.
    5. Papa M'B. P. N'Diaye, 2009. "Countercyclical Macro Prudential Policies in a Supporting Role to Monetary Policy," IMF Working Papers 09/257, International Monetary Fund.
    6. Jason Allen & Robert Amano & David P. Byrne & Allen W. Gregory, 2006. "Canadian City Housing Prices and Urban Market Segmentation," Working Papers 06-49, Bank of Canada.
    7. Nunes, Mauricio & Da Silva, Sergio, 2007. "Rational bubbles in emerging stockmarkets," MPRA Paper 4641, University Library of Munich, Germany.
    8. Greg Tkacz & Carolyn Wilkins, 2006. "Linear and Threshold Forecasts of Output and Inflation with Stock and Housing Prices," Working Papers 06-25, Bank of Canada.

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