Asset Price Beliefs and Optimal Monetary Policy
Colin Caines () and
Fabian Winkler ()
No 713, 2019 Meeting Papers from Society for Economic Dynamics
We characterize optimal monetary policy when agents have extrapolative beliefs about asset prices. Such boundedly rational expectations induce inefficient asset price and aggregate demand fluctuations. We find that the optimal monetary policy raises interest rates when expected capital gains or the level of current asset prices is high, but does not eliminate deviations of asset prices from their fundamental value. When the asset is in elastic supply, optimal policy also leans against the wind, tolerating low inflation and output when asset prices are too high. Optimal policy can be reasonably approximated by simple interest rate rules that respond to capital gains. Our results are robust to a wide range of belief specifications.
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