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Did the FED React to Asset Price Bubbles?

Author

Listed:
  • Luik Marc-Andre

    (University of Otago, Clyde Street 60, Dunedin 9054, New Zealand)

  • Wesselbaum Dennis

    (University of Otago, Clyde Street 60, Dunedin 9054, New Zealand)

Abstract

This paper investigates whether the Federal Reserve Bank (FED) reacted to asset price bubbles before the Great Recession and whether this affected macroeconomic variables. We estimate a DSGE model featuring a financial accelerator and a process for asset price bubbles with different Taylor-rule specifications. We find that a Taylor-rule with a feedback to Tobin’s Q and bubble shocks fits best. Our findings suggest that the FED followed a cleaning rather than a leaning approach prior to the global financial crisis (GFC). Then, we perform a counterfactual analysis and show that this policy created a lower interest rate prior to the GFC compared to a standard Taylor-rule without feedback to financial variables.

Suggested Citation

  • Luik Marc-Andre & Wesselbaum Dennis, 2021. "Did the FED React to Asset Price Bubbles?," The B.E. Journal of Macroeconomics, De Gruyter, vol. 21(2), pages 745-772, June.
    • Handle: RePEc:bpj:bejmac:v:21:y:2021:i:2:p:745-772:n:10
    DOI: 10.1515/bejm-2020-0116
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    Keywords

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    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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