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Asset Price Beliefs and Optimal Monetary Policy

Author

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  • Colin Caines

    (Federal Reserve Board)

  • Fabian Winkler

    (Federal Reserve Board)

Abstract

We characterize optimal monetary policy when agents have extrapolative beliefs about asset prices. Such boundedly rational expectations induce inefficient asset price and aggregate demand fluctuations. We find that the optimal monetary policy raises interest rates when expected capital gains or the level of current asset prices is high, but does not eliminate deviations of asset prices from their fundamental value. When the asset is in elastic supply, optimal policy also leans against the wind, tolerating low inflation and output when asset prices are too high. Optimal policy can be reasonably approximated by simple interest rate rules that respond to capital gains. Our results are robust to a wide range of belief specifications.

Suggested Citation

  • Colin Caines & Fabian Winkler, 2019. "Asset Price Beliefs and Optimal Monetary Policy," 2019 Meeting Papers 713, Society for Economic Dynamics.
  • Handle: RePEc:red:sed019:713
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    3. Ioana Manuela Mîndrican, 2023. "Monetary policy measures and strategies in the context of the adoption of the euro currency," Journal of Financial Studies, Institute of Financial Studies, vol. 8(14), pages 84-97, May.
    4. Polyzos, Efstathios, 2022. "Examining the asymmetric impact of macroeconomic policy in the UAE: Evidence from quartile impulse responses and machine learning," The Journal of Economic Asymmetries, Elsevier, vol. 26(C).

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    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

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