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How Should Monetary Policy Respond to Asset-Price Bubbles?

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  • Gruen, David
  • Plumb, Michael
  • Stone, Andrew

Abstract

We present a simple macroeconomic model that includes a role for an asset-price bubble. We then derive optimal monetary policy settings for two policymakers: a skeptic, for whom the best forecast of future asset prices is the current price; and an activist, whose policy recommendations take into account the complete stochastic implications of the bubble. We show that the activist’s recommendations depend sensitively on the detailed stochastic properties of the bubble. In some circumstances the activist clearly recommends tighter policy than the skeptic, but in others the appropriate recommendation is to be looser. Our results highlight the stringent informational requirements inherent in an activist policy approach to handling asset-price bubbles.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 833.

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Date of creation: 24 May 2005
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Publication status: Published in International Journal of Central Banking Number 3.Volume(2005): pp. 1-33
Handle: RePEc:pra:mprapa:833

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  1. Ben Bernanke & Mark Gertler, 1999. "Monetary policy and asset price volatility," Economic Review, Federal Reserve Bank of Kansas City, issue Q IV, pages 17-51.
  2. Svensson, Lars E. O., 1997. "Inflation forecast targeting: Implementing and monitoring inflation targets," European Economic Review, Elsevier, vol. 41(6), pages 1111-1146, June.
  3. David Gruen & Michael Plumb & Andrew Stone, 2003. "How Should Monetary Policy Respond to Asset-price Bubbles?," RBA Annual Conference Volume, in: Anthony Richards & Tim Robinson (ed.), Asset Prices and Monetary Policy Reserve Bank of Australia.
  4. Tim Robinson & Andrew Stone, 2006. "Monetary Policy, Asset-Price Bubbles, and the Zero Lower Bound," NBER Chapters, in: Monetary Policy with Very Low Inflation in the Pacific Rim, NBER-EASE, Volume 15, pages 43-90 National Bureau of Economic Research, Inc.
  5. Laurence Ball, 1993. "What determines the sacrifice ratio?," Working Papers 93-21, Federal Reserve Bank of Philadelphia.
  6. Glenn Rudebusch, 1995. "What are the lags in monetary policy?," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue feb3.
  7. Laurence Ball, 1997. "Efficient rules for monetary policy," Reserve Bank of New Zealand Discussion Paper Series G97/3, Reserve Bank of New Zealand.
  8. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 39(1), pages 195-214, December.
  9. Christopher Kent & Philip Lowe, 1997. "Asset-price Bubbles and Monetary Policy," RBA Research Discussion Papers rdp9709, Reserve Bank of Australia.
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