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Why Do Monetary Policymakers Lean With the Wing During Asset Price Booms?

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  • Wolfram Berger, Friedrich Kissmer

    ()
    (IESEG School of Management, Lille)

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    Abstract

    In 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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    File URL: http://www.ffe.esc-lille.com/papers/Vol6-1ms118Berger.pdf
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    Bibliographic Info

    Article provided by SKEMA Business School in its journal Frontiers in Finance and Economics.

    Volume (Year): 6 (2009)
    Issue (Month): 1 (April)
    Pages: 155-174

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    Handle: RePEc:ffe:journl:v:6:y:2009:i:1:p:155-174

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    Web page: http://www.ffe.esc-lille.com

    Related research

    Keywords: monetary policy; asset prices; credit crunch; boom bust cycles; forward-looking behavior;

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