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Monetary Policy and Rational Asset Price Bubbles

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  • Jordi Galí

Abstract

I examine the impact of alternative monetary policy rules on a rational asset price bubble, through the lens of an overlapping generations model with nominal rigidities. A systematic increase in interest rates in response to a growing bubble is shown to enhance the fluctuations in the latter, through its positive effect on bubble growth. The optimal monetary policy seeks to strike a balance between stabilization of the bubble and stabilization of aggregate demand. The paper's main findings call into question the theoretical foundations of the case for "leaning against the wind" monetary policies.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 18806.

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Date of creation: Feb 2013
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Handle: RePEc:nbr:nberwo:18806

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  1. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," NBER Working Papers, National Bureau of Economic Research, Inc 8403, National Bureau of Economic Research, Inc.
  2. Ben S. Bernanke & Mark Gertler, 2001. "Should Central Banks Respond to Movements in Asset Prices?," American Economic Review, American Economic Association, American Economic Association, vol. 91(2), pages 253-257, May.
  3. Manuel S. Santos & Michael Woodford, 1993. "Rational Asset Pricing Bubbles," Working Papers, Centro de Investigacion Economica, ITAM 9304, Centro de Investigacion Economica, ITAM.
  4. Tirole, Jean, 1985. "Asset Bubbles and Overlapping Generations," Econometrica, Econometric Society, Econometric Society, vol. 53(6), pages 1499-1528, November.
  5. Paul A. Samuelson, 1958. "An Exact Consumption-Loan Model of Interest with or without the Social Contrivance of Money," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 66, pages 467.
  6. Moritz Schularick & Alan M. Taylor, 2012. "Credit Booms Gone Bust: Monetary Policy, Leverage Cycles, and Financial Crises, 1870-2008," American Economic Review, American Economic Association, American Economic Association, vol. 102(2), pages 1029-61, April.
  7. Scheinkman, Jose A & Weiss, Laurence, 1986. "Borrowing Constraints and Aggregate Economic Activity," Econometrica, Econometric Society, Econometric Society, vol. 54(1), pages 23-45, January.
  8. Blanchard, Olivier, 2012. "Monetary Policy in the Wake of the Crisis," MIT Press Book Chapters, The MIT Press, in: In the Wake of the Crisis: Leading Economists Reassess Economic Policy, edition 1, volume 1, chapter 1, pages 7-13 The MIT Press.
  9. repec:mtp:titles:026201761x-01 is not listed on IDEAS
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  1. > Macroeconomics > Monetary Theory
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Cited by:
  1. Leroi Raputsoane, 2014. "Disaggregated Credit Extension and Financial Distress in South Africa," Working Papers, Economic Research Southern Africa 435, Economic Research Southern Africa.
  2. Abdullah Yavas, 2013. "Asset Price Bubbles and Monetary Policy," Working Papers, Hong Kong Institute for Monetary Research 102013, Hong Kong Institute for Monetary Research.

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