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Optimal monetary policy and rational asset bubbles

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  • Bonchi, Jacopo
  • Nisticò, Salvatore

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.

Suggested Citation

  • Bonchi, Jacopo & Nisticò, Salvatore, 2024. "Optimal monetary policy and rational asset bubbles," European Economic Review, Elsevier, vol. 170(C).
    • Handle: RePEc:eee:eecrev:v:170:y:2024:i:c:s0014292124001806
    DOI: 10.1016/j.euroecorev.2024.104851
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    More about this item

    Keywords

    Rational bubbles; Optimal monetary policy; Stochastic asset market participation; Consumption dispersion;
    All these keywords.

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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