Did the FED React to Asset Price Bubbles?

Marc-André Luik () and Dennis Wesselbaum

The B.E. Journal of Macroeconomics, 2021, vol. 21, issue 2, 745-772

Abstract: This paper investigates whether the Federal Reserve Bank (FED) reacted to asset price bubbles before the Great Recession and whether this affected macroeconomic variables. We estimate a DSGE model featuring a financial accelerator and a process for asset price bubbles with different Taylor-rule specifications. We find that a Taylor-rule with a feedback to Tobin’s Q and bubble shocks fits best. Our findings suggest that the FED followed a cleaning rather than a leaning approach prior to the global financial crisis (GFC). Then, we perform a counterfactual analysis and show that this policy created a lower interest rate prior to the GFC compared to a standard Taylor-rule without feedback to financial variables.

Keywords: Bayesian methods; bubbles; monetary policy (search for similar items in EconPapers)
JEL-codes: C11 E32 E44 E62 (search for similar items in EconPapers)
Date: 2021
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Working Paper: Did the FED REact to Asset Price Bubbles? (2016)
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DOI: 10.1515/bejm-2020-0116

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