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How Should Monetary Policy Respond to Asset-Price Bubbles?


  • Gruen, David
  • Plumb, Michael
  • Stone, Andrew


We present a simple macroeconomic model that includes a role for an asset-price bubble. We then derive optimal monetary policy settings for two policymakers: a skeptic, for whom the best forecast of future asset prices is the current price; and an activist, whose policy recommendations take into account the complete stochastic implications of the bubble. We show that the activist’s recommendations depend sensitively on the detailed stochastic properties of the bubble. In some circumstances the activist clearly recommends tighter policy than the skeptic, but in others the appropriate recommendation is to be looser. Our results highlight the stringent informational requirements inherent in an activist policy approach to handling asset-price bubbles.

Suggested Citation

  • Gruen, David & Plumb, Michael & Stone, Andrew, 2005. "How Should Monetary Policy Respond to Asset-Price Bubbles?," MPRA Paper 833, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:833

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    References listed on IDEAS

    1. Svensson, Lars E. O., 1997. "Inflation forecast targeting: Implementing and monitoring inflation targets," European Economic Review, Elsevier, vol. 41(6), pages 1111-1146, June.
    2. Laurence Ball, 1994. "What Determines the Sacrifice Ratio?," NBER Chapters,in: Monetary Policy, pages 155-193 National Bureau of Economic Research, Inc.
    3. 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.
    4. Ben S. 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.
    5. Ball, Laurence, 1999. "Efficient Rules for Monetary Policy," International Finance, Wiley Blackwell, vol. 2(1), pages 63-83, April.
    6. Stephen G. Cecchetti & Hans Genberg & Sushil Wadhwani, 2002. "Asset Prices in a Flexible Inflation Targeting Framework," NBER Working Papers 8970, National Bureau of Economic Research, Inc.
    7. 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.
    8. Glenn D. Rudebusch, 1995. "What are the lags in monetary policy?," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue feb3.
    9. Christopher Kent & Philip Lowe, 1997. "Asset-price Bubbles and Monetary Policy," RBA Research Discussion Papers rdp9709, Reserve Bank of Australia.
    10. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
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    JEL classification:

    • G00 - Financial Economics - - General - - - General
    • G0 - Financial Economics - - General

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