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Should central banks lean against changes in asset prices?

  • Sylvain Leduc
  • Jean-Marc Natal

How should monetary policy be conducted in the presence of endogenous feedback loops between asset prices, firms’ financial health, and economic activity? We reconsider this question in the context of the financial accelerator model and show that, when the level of natural output is inefficient, the optimal monetary policy under commitment leans considerably against movements in asset prices and risk premia. We demonstrate that an endogenous feedback loop is crucial for this result and that price stability is otherwise quasi-optimal absent this feature. We also show that the optimal policy can be closely approximated and implemented using a speed-limit rule that places a substantial weight on the growth of financial variables.

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Paper provided by Federal Reserve Bank of San Francisco in its series Working Paper Series with number 2011-15.

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Date of creation: 2011
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Handle: RePEc:fip:fedfwp:2011-15
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  9. Robert J. Tetlow & Peter von zur Muehlen, 2002. "Monetary Policy, Asset Prices, and Misspecification: the robust approach to bubbles with model uncertainty," Computing in Economics and Finance 2002 335, Society for Computational Economics.
  10. Richard Dennis, 2001. "Solving for Optimal Simple Rules in Rational Expectations Models," Computing in Economics and Finance 2001 30, Society for Computational Economics.
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  12. Faia, Ester & Monacelli, Tommaso, 2007. "Optimal interest rate rules, asset prices, and credit frictions," Journal of Economic Dynamics and Control, Elsevier, vol. 31(10), pages 3228-3254, October.
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