Monetary policy responses amid credit and asset booms and busts

Robert Pavasuthipaisit ()

MPRA Paper from University Library of Munich, Germany

Abstract: This paper examines the conduct of monetary policy in the presence of credit and asset booms and busts. Conventional wisdom is for the central bank to respond to asset prices and other financial indicators insofar as these factors affect the forecasts of inflation. This paper finds that such strategy is far from being optimal. This paper derives optimal policy under commitment in a standard financial accelerator model and finds that in the optimal equilibrium, the central bank responds to a rise in productivity growth by making a credible commitment to keep the rate of return on capital below the trend. This causes net worth to be countercyclical, which is the key mechanism that allows the central bank to successfully stabilize the economy. The countercyclicality of net worth is consistent with what can be found in the data on the periods following the Volcker chairmanship of the FOMC.

Keywords: Financial accelerator; optimal policy under commitment; asset prices; credit market frictions; countercyclicality of net worth (search for similar items in EconPapers)
JEL-codes: E44 E50 E58 (search for similar items in EconPapers)
Date: 2007-06
New Economics Papers: this item is included in nep-mac and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:4491

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