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Boom-Busts in Asset Prices, Economic Instability, and Monetary Policy

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  • Michael D. Bordo
  • Olivier Jeanne

Abstract

The link between monetary policy and asset price movements has been of perennial interest to policy makers. In this paper we consider the potential case for pre-emptive monetary restrictions when asset price reversals can have serious effects on real output. First, we provide some historical background on two famous asset price reversals: the U.S. stock market crash of 1929 and the bursting of the Japanese bubble in 1989. We then present some stylized facts on boom-bust dynamics in stock and property prices in developed economies. We then discuss the case for a pre-emptive monetary policy in the context of a stylized 'Dynamic New Keynesian' framework with collateral constraints in the productive sector. We find that whether such a policy is warranted depends on the economic conditions in a complex, non-linear way. The optimal policy cannot be summarized by a simple policy rule of the type considered in the inflation-targeting literature.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 8966.

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Date of creation: May 2002
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Publication status: published as Bordo, M. C. and O. Jeanne. "Monetary Policy And Asset Prices: Does 'Benign Neglect' Make Sense?," International Finance, 2002, v5(2,Summer), 139-164.
Handle: RePEc:nbr:nberwo:8966

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  1. Stephen G. Cecchetti & Anil K Kashyap, 1995. "International Cycles," NBER Working Papers 5310, National Bureau of Economic Research, Inc.
  2. Hart, Oliver & Moore, John, 1994. "A Theory of Debt Based on the Inalienability of Human Capital," The Quarterly Journal of Economics, MIT Press, vol. 109(4), pages 841-79, November.
  3. Garber, Peter M, 1990. "Famous First Bubbles," Journal of Economic Perspectives, American Economic Association, vol. 4(2), pages 35-54, Spring.
  4. Ben Bernanke & Mark Gertler, 2000. "Monetary Policy and Asset Price Volatility," NBER Working Papers 7559, National Bureau of Economic Research, Inc.
  5. Eugene White & Frederic Mishkin, 2002. "U.S.Stock Market Crashes and Their Aftermath: Implications for Monetary Policy," Departmental Working Papers 200208, Rutgers University, Department of Economics.
  6. Barry Eichengreen & Michael D. Bordo, 2002. "Crises Now and Then: What Lessons from the Last Era of Financial Globalization," NBER Working Papers 8716, National Bureau of Economic Research, Inc.
  7. Christina D. Romer, 1988. "The Great Crash and the Onset of the Great Depression," NBER Working Papers 2639, National Bureau of Economic Research, Inc.
  8. Ben S. Bernanke, 1983. "Non-Monetary Effects of the Financial Crisis in the Propagation of the Great Depression," NBER Working Papers 1054, National Bureau of Economic Research, Inc.
  9. A. Senhadji Semlali & Charles Collyns, 2002. "Lending Booms, Real Estate Bubbles and the Asian Crisis," IMF Working Papers 02/20, International Monetary Fund.
  10. Andrew J. Filardo, 2000. "Monetary policy and asset prices," Economic Review, Federal Reserve Bank of Kansas City, issue Q III, pages 11-37.
  11. Takatoshi Ito & Tokuo Iwaisako, 1995. "Explaining Asset Bubbles in Japan," NBER Working Papers 5358, National Bureau of Economic Research, Inc.
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