Shedding lights on Leaning Against the Wind

Federica Vassalli and Massimiliano Tancioni (massimiliano.tancioni@uniroma1.it)

No 234, Working Papers in Public Economics from Department of Economics and Law, Sapienza University of Roma

Abstract: The efficacy of monetary policy intervention against stock market bubbles depends on monetary policy shock identification. We estimate a Bayesian VAR identified with mixed zero-sign restriction, where we distinguish a pure monetary policy shock from a central bank information shock. We show that the two shocks affect the asset price components differently, where the asset price is the sum between the fundamental and the bubbly components. A pure tightening monetary policy shock reduces the S&P500 Index but causes the bubble to increase. In contrast, by disclosing information on the economy's future path, a central bank information shock increases the fundamental component causing a drop in the bubble. Ignoring the distinction between the two types of monetary shock helps to explain the ambiguity surrounding the efficacy of leaning against the wind policy in terms of the ability to deflate a bubble.

Keywords: Monetary Policy; Bubbles; LAW; BVAR (search for similar items in EconPapers)
JEL-codes: E44 E52 E58 G12 (search for similar items in EconPapers)
Pages: 35
Date: 2023-01
New Economics Papers: this item is included in nep-ban, nep-cba and nep-mon
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