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Should monetary policy respond to asset price bubbles? : some experimental results

  • Andrew J. Filardo

Should central banks respond to asset price bubbles? This paper explores this monetary policy question in a hypothetical economy subject to asset price bubbles. Despite the highly stylized structure of the model, the results reveal several practical monetary policy lessons. First, a monetary authority should generally respond to asset prices as long as asset prices contain reliable information about inflation and output. Second, this finding holds even if a monetary authority cannot distinguish between fundamental and bubble asset price behavior. Third, a monetary authority’s desire to respond to asset prices falls dramatically as its preference to smooth interest rates rises. Finally, a monetary authority should not respond to asset prices if there is considerable uncertainty about the macroeconomic role of asset prices.

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File URL: http://www.kansascityfed.org/Publicat/Reswkpap/pdf/rwp01-04.pdf
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Paper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number RWP 01-04.

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Date of creation: 2001
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Handle: RePEc:fip:fedkrw:rwp01-04
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  1. Ben S. Bernanke & Michael Woodford, 1997. "Inflation forecasts and monetary policy," Proceedings, Federal Reserve Bank of Cleveland, pages 653-686.
  2. Glenn Rudebusch & Lars E.O. Svensson, 1999. "Policy Rules for Inflation Targeting," NBER Chapters, in: Monetary Policy Rules, pages 203-262 National Bureau of Economic Research, Inc.
  3. Goodhart, Charles & Hofmann, Boris, 2000. "Do Asset Prices Help to Predict Consumer Price Inflation?," Manchester School, University of Manchester, vol. 68(0), pages 122-40, Supplemen.
  4. Sack, Brian & Wieland, Volker, 2000. "Interest-rate smoothing and optimal monetary policy: a review of recent empirical evidence," Journal of Economics and Business, Elsevier, vol. 52(1-2), pages 205-228.
  5. William Poole, 1999. "Monetary policy rules?," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 3-12.
  6. Morris A. Davis & Michael G. Palumbo, 2001. "A primer on the economics and time series econometrics of wealth effects," Finance and Economics Discussion Series 2001-09, Board of Governors of the Federal Reserve System (U.S.).
  7. James M. Poterba, 2000. "Stock Market Wealth and Consumption," Journal of Economic Perspectives, American Economic Association, vol. 14(2), pages 99-118, Spring.
  8. Ben Bernanke & Mark Gertler, 1999. "Monetary policy and asset price volatility," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 77-128.
  9. Cecchetti, Stephen G. & Kashyap, Anil K, 1996. "International cycles," European Economic Review, Elsevier, vol. 40(2), pages 331-360, February.
  10. Kenneth D. West, 1986. "A Specification Test for Speculative Bubbles," NBER Working Papers 2067, National Bureau of Economic Research, Inc.
  11. Timothy Cogley, 1999. "Should the Fed take deliberate steps to deflate asset price bubbles?," Economic Review, Federal Reserve Bank of San Francisco, pages 42-52.
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