Monetary Policy and Asset Prices: Does ‘Benign Neglect’ Make Sense?

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Abstract

The link between monetary policy and asset price movements has been of perennial interest to policy makers. In this paper we consider the potential case for pre–emptive monetary restrictions when asset price reversals can have serious effects on real output. First, we present some stylized facts on boom?bust dynamics in stock and property prices in developed economies. We then discuss the case for a pre–emptive monetary policy in the context of a stylized framework with collateral constraints in the productive sector. We find that whether such a policy is warranted depends on the economic conditions in a complex, nonlinear way. The optimal policy cannot be summarized by a simple policy rule of the type considered in the inflation–targeting literature.

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