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Monetary Policy and Asset Price Volatility: Should We Refill the Bernanke-Gertler Prescription?

Bernanke and Gertler’s influential 1999 article “Asset Price Bubbles and Monetary Policy” made the case that monetary policy should respond to asset prices only to the extent that they have implications for future inflation. This paper revisits that prescription in light of the 2007–09 financial crisis. After reviewing the Bernanke-Gertler logic, the paper surveys the recent evolution of views on the appropriate policy response to asset price fluctuations, and discusses the conditions under which a proactive policy would be justified. There is almost no discernible relationship between interest rates and stock and property prices across countries during the years leading up to the crisis, however. While a theoretical case could be made to give some weight to financial stability in setting monetary policy, the evidence presented in the paper suggests that incremental interest rate adjustments are unlikely to be effective in restraining excessive asset price appreciation.

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Paper provided by Department of Economics, Williams College in its series Department of Economics Working Papers with number 2011-04.

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Length: 35 pages
Date of creation: May 2011
Date of revision: Jun 2011
Handle: RePEc:wil:wileco:2011-04
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  1. Refet Gürkaynak & Brian Sack, 2005. "Do Actions Speak Louder Than Words?The Response of Asset Prices to Monetary Policy Actions and Statements," Computing in Economics and Finance 2005 323, Society for Computational Economics.
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  7. 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.
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  9. Adam S. Posen, 2003. "It Takes More than a Bubble to Become Japan," Working Paper Series WP03-9, Peterson Institute for International Economics.
  10. Michael D. Bordo & David C. Wheelock, 1998. "Price stability and financial stability: the historical record," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 41-62.
  11. Edward L. Glaeser & Joshua D. Gottlieb & Joseph Gyourko, 2012. "Can Cheap Credit Explain the Housing Boom?," NBER Chapters, in: Housing and the Financial Crisis, pages 301-359 National Bureau of Economic Research, Inc.
  12. Leonardo Gambacorta, 2009. "Monetary policy and the risk-taking channel," BIS Quarterly Review, Bank for International Settlements, December.
  13. Jarociński, Marek & Smets, Frank, 2008. "House Prices and the stance of Monetary Policy," Working Paper Series 0891, European Central Bank.
  14. Bill Dupor, 2002. "The Natural Rate of Q," American Economic Review, American Economic Association, vol. 92(2), pages 96-101, May.
  15. Del Negro, Marco & Otrok, Christopher, 2007. "99 Luftballons: Monetary policy and the house price boom across U.S. states," Journal of Monetary Economics, Elsevier, vol. 54(7), pages 1962-1985, October.
  16. Jane Dokko & Brian Doyle & Michael T. Kiley & Jinill Kim & Shane Sherlund & Jae Sim & Skander Van den Heuvel, 2009. "Monetary policy and the housing bubble," Finance and Economics Discussion Series 2009-49, Board of Governors of the Federal Reserve System (U.S.).
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