Can monetary policy tame asset price fluctuations? Evaluating the dynamic trade-offs

Using an external instrumental variable within a Proxy TVP-SVAR framework, we investigate the dynamic trade-offs involved in employing countercyclical monetary policy to moderate asset price fluctuations. Our findings show that tightening monetary policy simultaneously curtails the money supply, suppresses asset prices, and depresses economic activity. Notably, asset prices respond more aggressively, yet recover more quickly compared to output and inflation. These impulse responses illustrate that countercyclical monetary interventions can effectively stabilize asset markets—especially when timed strategically during pronounced asset price surges—thus minimizing associated economic costs. However, achieving asset price stability often entails sacrificing some degree of monetary stability, underscoring an inherent policy trade-off. Our results provide empirical guidance for policymakers, emphasizing that, with optimal timing, monetary policy interventions can mitigate asset price bubbles efficiently, achieving substantial financial stability benefits with manageable economic trade-offs.