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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
Date of revision:
Handle: RePEc:fip:fedfwp:2011-15
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  1. Bernardino Adao & Isabel Correia & Pedro Teles, 2003. "Gaps and Triangles," Review of Economic Studies, Wiley Blackwell, vol. 70(4), pages 699-713, October.
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  6. De Fiore, Fiorella & Tristani, Oreste, 2009. "Optimal monetary policy in a model of the credit channel," Working Paper Series 1043, European Central Bank.
  7. Carlstrom, Charles T & Fuerst, Timothy S, 1997. "Agency Costs, Net Worth, and Business Fluctuations: A Computable General Equilibrium Analysis," American Economic Review, American Economic Association, vol. 87(5), pages 893-910, December.
  8. Bernanke, Ben S. & Gertler, Mark & Gilchrist, Simon, 1999. "The financial accelerator in a quantitative business cycle framework," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 21, pages 1341-1393 Elsevier.
  9. Charles T. Carlstrom & Timothy S. Fuerst & Matthias Paustian, 2010. "Optimal Monetary Policy in a Model with Agency Costs," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(s1), pages 37-70, 09.
  10. Vasco Cúrdia & Michael Woodford, 2009. "Credit frictions and optimal monetary policy," BIS Working Papers 278, Bank for International Settlements.
  11. Pierpaolo Benigno & Michael Woodford, 2004. "Inflation Stabilization and Welfare: The Case of a Distorted Steady State," NBER Working Papers 10838, National Bureau of Economic Research, Inc.
  12. Gilchrist, Simon & Leahy, John V., 2002. "Monetary policy and asset prices," Journal of Monetary Economics, Elsevier, vol. 49(1), pages 75-97, January.
  13. Gertler, Mark & Karadi, Peter, 2011. "A model of unconventional monetary policy," Journal of Monetary Economics, Elsevier, vol. 58(1), pages 17-34, January.
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