How Should Monetary Policy Respond to Asset-Price Bubbles?
by David Gruen (Australian Treasury), Michael Plumb and Andrew Stone (Reserve Bank of Australia)
We present a simple macroeconomic model that includes
a role for an asset-price bubble. We then derive optimal
monetary policy settings for two policymakers: a skeptic, for
whom the best forecast of future asset prices is the current
price; and an activist, whose policy recommendations take
into account the complete stochastic implications of the
bubble. We show that the activistís recommendations depend
sensitively on the detailed stochastic properties of the bubble.
In some circumstances the activist clearly recommends
tighter policy than the skeptic, but in others the appropriate
recommendation is to be looser. Our results highlight the
stringent informational requirements inherent in an activist
policy approach to handling asset-price bubbles.
JEL Codes: E32, E52, E60.
Full article (PDF, 31 pages 243 kb)