On the Nexus of Monetary Policy and Financial Stability: Novel Asset Market Monitoring Tools for Building Economic Resilience and Mitigating Financial Risks

In this note we argue that asset pricing bubbles are an important source of financial instabilities. First, the literature has tended to overlook bubbles and their consequences under the premise that they are hard to detect in real time. We suggest that novel statistical techniques allow us to overcome those prejudices as they provide valuable signals of emerging exuberance in real‐time. Second, monetary policy has been slow to recognize that financial instability arising from bubbles can have adverse effects on the transmission mechanism of monetary policy itself and on the types of risks faced by policymakers. We argue that measuring and monitoring episodes of exuberance in housing—but also in other asset classes—can be useful not just for thinking about macroprudential strategies but also to conduct risk analysis for monetary policy.