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Monetary Policy and Rational Asset Price Bubbles

  • Jordi Gal?
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    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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    Article provided by American Economic Association in its journal American Economic Review.

    Volume (Year): 104 (2014)
    Issue (Month): 3 (March)
    Pages: 721-52

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    Handle: RePEc:aea:aecrev:v:104:y:2014:i:3:p:721-52
    Note: DOI: 10.1257/aer.104.3.721
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    1. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2005. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 113(1), pages 1-45, February.
    2. Klaus Adam, 2003. "Learning and Equilibrium Selection in a Monetary Overlapping Generations Model with Sticky Prices," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 887-907.
    3. Otmar Issing, 2009. "Asset Prices and Monetary Policy," Cato Journal, Cato Journal, Cato Institute, vol. 29(1), pages 45-51, Winter.
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