Optimal monetary policy and rational asset bubbles

Jacopo Bonchi and Salvatore Nisticò

European Economic Review, 2024, vol. 170, issue C

Abstract: Within a tractable New Keynesian model with stochastic asset-market participation, we analyze the normative implications of bubbly fluctuations for monetary policy. For a welfare-maximizing central bank, bubbly fluctuations imply an endogenous tradeoff between stabilizing cross-sectional consumption dispersion and stabilizing inflation/output. Inflation targeting is thus a generally suboptimal monetary-policy regime, despite the “divine coincidence”. Optimal deviations from inflation targeting are larger if the economy fluctuates around a balanced-growth path with small or no equilibrium bubbles, in which case the endogenous tradeoff is more stringent. The specific optimal-policy response to bubbly fluctuations depends however on the intrinsic nature of latter, and the associated effects on consumption dispersion.

Keywords: Rational bubbles; Optimal monetary policy; Stochastic asset market participation; Consumption dispersion (search for similar items in EconPapers)
JEL-codes: E21 E32 E44 E58 (search for similar items in EconPapers)
Date: 2024
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Working Paper: Optimal Monetary Policy and Rational Asset Bubbles (2023)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:eecrev:v:170:y:2024:i:c:s0014292124001806

DOI: 10.1016/j.euroecorev.2024.104851

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