Monetary Policy and Asset Price Overshooting: A Rationale for the Wall/Main Street Disconnect

Ricardo Caballero () and Alp Simsek

No 15163, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We analyze optimal monetary policy and its implications for asset prices, when aggregate demand has inertia and responds to asset prices with a lag. If there is a negative output gap, the central bank optimally overshoots aggregate asset prices (asset prices are initially pushed above their steady-state levels consistent with current potential output). Overshooting leads to a temporary disconnect between the performance of financial markets and the real economy, but it accelerates the recovery. When there is a lower-bound constraint on the discount rate, overshooting becomes a concave and non-monotonic function of the output gap: the asset price boost is low for a deeply negative initial output gap, grows as the output gap improves over a range, and shrinks toward zero as the output gap improves further. This pattern also implies that good macroeconomic news is better news for asset prices when the output gap is more negative. Finally, we document that during the Covid-19 recovery, the policy-induced overshooting was large---sufficient to explain the high levels of stock and house prices in 2021.

Keywords: Monetary policy; Covid-19; Macroeconomic news (search for similar items in EconPapers)
JEL-codes: E21 E32 E43 E44 E52 (search for similar items in EconPapers)
Date: 2022-06
New Economics Papers: this item is included in nep-mac, nep-mon and nep-ore
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

Downloads: (external link)
https://cepr.org/publications/DP15163 (application/pdf)
CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org

Related works:
Journal Article: Monetary Policy and Asset Price Overshooting: A Rationale for the Wall/Main Street Disconnect (2024)
Working Paper: Monetary Policy and Asset Price Overshooting: A Rationale for the Wall/Main Street Disconnect (2022)
Working Paper: Monetary Policy and Asset Price Overshooting: A Rationale for the Wall/Main Street Disconnect (2020)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cpr:ceprdp:15163

Ordering information: This working paper can be ordered from
https://cepr.org/publications/DP15163

Access Statistics for this paper

More papers in CEPR Discussion Papers from C.E.P.R. Discussion Papers Centre for Economic Policy Research, 33 Great Sutton Street, London EC1V 0DX.
Bibliographic data for series maintained by ().