The Monetary Policy Implications of Behavioural Asset Bubbles
I introduce behavioural asset pricing rules into a wider dynamic stochastic general equilibrium framework. Asset price bubbles emerge endogenously within the model. I find that in this model the only monetary policy that would be likely to enhance welfare is a counter-intuitive ‘running with the wind’ policy. I conclude that the optimal policy is highly dependent on the nature of the behavioural rules that are stipulated. Given that monetary authorities have limited information about the ways in which agents actually behave, a systematic monetary policy response to asset price misalignments is unlikely to enhance welfare.
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