Paper #1293

Title:

Monetary policy and rational asset price bubbles

Author:

Jordi Galí

Date:

April 2011 (Revised: August 2013)

Abstract:

I examine the impact of alternative monetary policy rules on a rational asset price bubble, through the lens of an overlapping generations model with nominal rigidities. A systematic increase in interest rates in response to a growing bubble is shown to enhance the fluctuations in the latter, through its positive effect on bubble growth. The optimal monetary policy seeks to strike a balance between stabilization of the bubble and stabilization of aggregate demand. The paper's main findings call into question the theoretical foundations of the case for "leaning against the wind" monetary policies.

Keywords:

monetary policy rules, stabilization policies, asset price volatility

JEL codes:

E44, E52

Area of Research:

Macroeconomics and International Economics

Published in:

American Economic Review, forthcoming

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