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Asset Price Bubbles and Monetary Policy: Why Central Banks Have Been Wrong and What Should Be Done

  • Thomas I. Palley


    (Economics for Democratic & Open Societies, Washington DC, and Visiting Scholar at the Macroeconomic Policy Institute (IMK), Germany)

Over the last several years debate over monetary policy has focused on two issues, inflation targeting and asset price bubbles. This paper explores the case for explicitly targeting asset price bubbles, a policy that the Federal Reserve Bank has opposed on the grounds that it is both infeasible and undesirable. The paper argues that the Fed is wrong on both counts. Asset price bubbles are identifiable. Bubbles also do significant economic harm through the debt footprint effects they leave behind and through interest rate blunderbuss effects resulting from attempts to mitigate the aggregate demand impact of bubbles. Managing bubbles calls for additional policy instruments. These can be provided a system of asset based reserve requirements (ABRR).

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Paper provided by IMK at the Hans Boeckler Foundation, Macroeconomic Policy Institute in its series IMK Working Paper with number 05-2008.

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Length: 19 pages
Date of creation: 2008
Date of revision:
Handle: RePEc:imk:wpaper:05-2008
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  1. Ben S. Bernanke & Frederic S. Mishkin, 1997. "Inflation Targeting: A New Framework for Monetary Policy?," NBER Working Papers 5893, National Bureau of Economic Research, Inc.
  2. Thomas Palley, 2004. "Asset-based reserve requirements: reasserting domestic monetary control in an era of financial innovation and instability," Review of Political Economy, Taylor & Francis Journals, vol. 16(1), pages 43-58.
  3. Thomas Palley, 2007. "Asset-based Reserve Requirements: A Response," Review of Political Economy, Taylor & Francis Journals, vol. 19(4), pages 575-578.
  4. Thomas Palley, 2003. "Asset Price Bubbles and the Case for Asset-Based Reserve Requirements," Challenge, M.E. Sharpe, Inc., vol. 46(3), pages 53-72, May.
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