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Why Do Monetary Policymakers Lean With the Wing During Asset Price Booms?

Friedrich Kissmer Wolfram Berger ()
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Friedrich Kissmer Wolfram Berger: IESEG School of Management, Lille

Frontiers in Finance and Economics, 2009, vol. 6, issue 1, 155-174

Abstract: In this paper we explore the optimal policy reaction to an asset price boom. Empirical evidence shows that the monetary policy stance is typically loose during asset price booms. Emplying a modified New Keneysian sticky price model we show that this policy of leaning with the wind can be attributed to the forward-looking nature of the private sector's expectations. Agents incorporate the macroeconomic consequences of a looming asset price bust in their expectations. The expectation-induced deviations of outpout and inflation from their targets enforce a monetary loosening before the bust occurs. Futhermore, we argue that a policy of benign neglect towards asset price movements, as often advanced by monetary practitioners, is (generally) not optimal in welfare terms.

Keywords: monetary policy; asset prices; credit crunch; boom bust cycles; forward-looking behavior (search for similar items in EconPapers)
JEL-codes: E44 E52 E58 (search for similar items in EconPapers)
Date: 2009
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Handle: RePEc:ffe:journl:v:6:y:2009:i:1:p:155-174