Monetary Policy and Asset Prices: Does "Benign Neglect" Make Sense?, Issues 2002-2225
The link between monetary policy and asset price movements has been of perennial interest to policymakers. In this paper, we consider the potential case for preemptive monetary restrictions when asset price reversals can have serious effects on real output. First, we present some stylized facts on boom-bust dynamics in stock and property prices in developed economies. We then discuss the case for a preemptive monetary policy in the context of a stylized model. We find that the optimal policy depends on the economic conditions in a complex, nonlinear way and cannot be summarized by a simple policy rule of the type considered in the inflation-targeting literature.
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aggregate supply Ancillary Variables assessment asset market boom asset price boom asset price reversals banking crises benign neglect Bernanke and Gertler boom-bust episodes booms and busts booms in asset Bordo and Jeanne bust in asset bust starts central banks collateral-induced credit crunch countries credit constraint criterion deflator economic ex ante channel ex post Figure financial crises financial instability financial stability Finland firms GDP deflator Irrational Exuberance lending-in-last-resort levels of optimism loss function macroeconomic objectives macroeconomic variables monetary authorities monetary policy depends moving average nominal wage non-linear Nordic Countries objectives of monetary OECD optimal monetary policy optimal policy paper policy rules preemptive monetary restriction price of collateral private sector proactive monetary policy proactive monetary stance proactive policy property price index real interest rate real property prices realization of Q reduced-form model restricting monetary policy sacrifice in terms stock market stock prices stylized facts stylized model supply shock Taylor rule trade-off