Why Do Monetary Policymakers Lean With the Wing During Asset Price Booms?
AbstractIn this paper we explore the optimal policy reaction to an asset price boom. Empirical evidence shows that the monetary policy stance is typically loose during asset price booms. Emplying a modified New Keneysian sticky price model we show that this policy of leaning with the wind can be attributed to the forward-looking nature of the private sector's expectations. Agents incorporate the macroeconomic consequences of a looming asset price bust in their expectations. The expectation-induced deviations of outpout and inflation from their targets enforce a monetary loosening before the bust occurs. Futhermore, we argue that a policy of benign neglect towards asset price movements, as often advanced by monetary practitioners, is (generally) not optimal in welfare terms.
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Bibliographic InfoArticle provided by SKEMA Business School in its journal Frontiers in Finance and Economics.
Volume (Year): 6 (2009)
Issue (Month): 1 (April)
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monetary policy; asset prices; credit crunch; boom bust cycles; forward-looking behavior;
Find related papers by JEL classification:
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
- E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
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