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Monetary Policy, Asset-Price Bubbles and the Zero Lower Bound

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  • Tim Robinson
  • Andrew Stone

Abstract

We use a simple model of a closed economy to study the recommendations of monetary policy-makers, attempting to respond optimally to an asset-price bubble whose stochastic properties they understand. We focus on the impact which the zero lower bound (ZLB) on nominal interest rates has on the recommendations of such policy-makers. For a given target inflation rate, we identify several different forms of `insurance' which policy-makers could potentially take out against encountering the ZLB due to the future bursting of a bubble. Even with perfect knowledge of the bubble process, however, which of these will be optimal varies from one type of bubble to another and, for certain bubbles, from one period to the next. It is therefore difficult to say whether the ZLB should cause policy-makers to operate policy more tightly or loosely than they would otherwise do, while a bubble is growing -- even after abstracting from the informational difficulties they face in practice. We also examine the implications of the ZLB for policy-makers' preferences as to their inflation target. Policy-makers who wish to avoid concerns about the ZLB should take care not to set too low a target -- especially if the neutral real interest rate is low.

Suggested Citation

  • Tim Robinson & Andrew Stone, 2005. "Monetary Policy, Asset-Price Bubbles and the Zero Lower Bound," NBER Working Papers 11105, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:11105
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    References listed on IDEAS

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    Cited by:

    1. Cinzia Alcidi , Alessandro Flamini, Andrea Fracasso, 2005. ""Taylored rules". Does one fit (or hide) all?," IHEID Working Papers 04-2005, Economics Section, The Graduate Institute of International Studies, revised Apr 2006.
    2. David Gruen & Michael Plumb & Andrew Stone, 2005. "How Should Monetary Policy Respond to Asset-Price Bubbles?," International Journal of Central Banking, International Journal of Central Banking, vol. 1(3), December.
    3. Gordon Menzies & Ron Bird & Peter B. Dixon & Maureen T. Rimmer, 2011. "Asset Price Regulators, Unite: You have the Macroeconomy to Win and the Microeconomic Losses are Small," The Economic Record, The Economic Society of Australia, vol. 87(278), pages 449-464, September.
    4. Koppány, Krisztián, 2007. "Likviditási csapda és deflációs spirál egy inflációs célt követő modellben - a hitelesség szerepe
      [A liquidity trap and deflationary spiral in a model for pursuing an inflation target - the role of
      ," Közgazdasági Szemle (Economic Review - monthly of the Hungarian Academy of Sciences), Közgazdasági Szemle Alapítvány (Economic Review Foundation), vol. 0(11), pages 974-1003.
    5. Tim Robinson & Andrew Stone, 2006. "Monetary Policy, Asset-Price Bubbles, and the Zero Lower Bound," NBER Chapters,in: Monetary Policy with Very Low Inflation in the Pacific Rim, NBER-EASE, Volume 15, pages 43-90 National Bureau of Economic Research, Inc.
    6. Kenneth Kuttner, 2011. "Monetary Policy and Asset Price Volatility: Should We Refill the Bernanke-Gertler Prescription?," Department of Economics Working Papers 2011-04, Department of Economics, Williams College, revised Jun 2011.
    7. Takashi Kamihigashi, 2011. "Recurrent Bubbles," The Japanese Economic Review, Japanese Economic Association, vol. 62(1), pages 27-62, March.
    8. Ansgar Belke & Thorsten Polleit, 2006. "Monetary policy and dividend growth in Germany: long-run structural modelling versus bounds testing approach," Applied Economics, Taylor & Francis Journals, vol. 38(12), pages 1409-1423.
    9. Ansgar Belke & Thorsten Polleit, 2005. "(How) Do Stock Market Returns React to Monetary Policy? - An ARDL Cointegration Analysis for Germany," Diskussionspapiere aus dem Institut für Volkswirtschaftslehre der Universität Hohenheim 253/2005, Department of Economics, University of Hohenheim, Germany.
    10. David L. Haugh, 2008. "Monetary Policy under Uncertainty about the Nature of Asset-Price Shocks," International Journal of Central Banking, International Journal of Central Banking, vol. 4(4), pages 39-83, December.
    11. Wolfram Berger & Friedrich Kissmer, 2013. "Monetary Policy and Asset Prices: When Cleaning Up Hits the Zero Lower Bound," Swiss Journal of Economics and Statistics (SJES), Swiss Society of Economics and Statistics (SSES), vol. 149(III), pages 291-312, September.

    More about this item

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General

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