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How Should Monetary Policy Respond to Asset-Price Bubbles?

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

Abstract

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

    as
    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.
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    JEL classification:

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

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