Working Paper

Should central banks lean against changes in asset prices?

Abstract: How should monetary policy be conducted in the presence of endogenous feedback loops between asset prices, firms? financial health, and economic activity? We reconsider this question in the context of the financial accelerator model and show that, when the level of natural output is inefficient, the optimal monetary policy under commitment leans considerably against movements in asset prices and risk premia. We demonstrate that an endogenous feedback loop is crucial for this result and that price stability is otherwise quasi-optimal absent this feature. We also show that the optimal policy can be closely approximated and implemented using a speed-limit rule that places a substantial weight on the growth of financial variables.

Keywords: Monetary policy; Asset pricing;

Bibliographic Information

Provider: Federal Reserve Bank of San Francisco

Part of Series: Working Paper Series

Publication Date: 2011

Number: 2011-15