Asset Price Learning and Optimal Monetary Policy

RePEc Short ID: pwi389
ORCID iD: 0000-0002-1241-7941

Caines, Colin C.; Winkler, Fabian

doi:10.17016/IFDP.2018.1236

Working Paper

Asset Price Learning and Optimal Monetary Policy

Abstract: We characterize optimal monetary policy when agents are learning about endogenous asset prices. Boundedly rational expectations induce inefficient equilibrium asset price fluctuations which translate into inefficient aggregate demand fluctuations. We find that the optimal policy raises interest rates when expected capital gains, and the level of current asset prices, is high. The optimal policy does not eliminate deviations of asset prices from their fundamental value. When monetary policymakers are information-constrained, optimal policy can be reasonably approximated by simple interest rate rules that respond to capital gains. Our results are robust to a wide range of belief specifications as well as to the inclusion of an investment channel.

Keywords: Optimal monetary policy; Natural real Interest rate; Learning; Asset price volatility; Leaning against the wind;

JEL Classification: E44; E52;

https://doi.org/10.17016/IFDP.2018.1236