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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

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File(s): File format is application/pdf https://www.federalreserve.gov/econres/ifdp/files/ifdp1236.pdf

Authors

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: International Finance Discussion Papers

Publication Date: 2018-08-21

Number: 1236

Pages: 45 pages