International Finance Discussion Papers (IFDP)

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August 2018 (Revised May 2019)

Asset Price Learning and Optimal Monetary Policy

Colin C. Caines and Fabian Winkler

Abstract:

We characterize optimal monetary policy when agents learn about endogenous asset prices. Learning leads to inefficient asset price fluctuations and distortions in consumption and investment decisions. We find that the policy-relevant natural real interest rate increases with subjective asset price beliefs. Optimal monetary policy therefore raises interest rates when expected capital gains are high. When the asset is not in fixed supply, optimal policy also "leans against the wind". In a simple calibration of the model, a positive response to capital gains in simple interest rate rules is beneficial. Our results are robust to alternative belief specifications.

Accessible materials (.zip)

Original paper: PDF

Keywords: Optimal Monetary Policy, Asset Prices, Natural Real Interest Rate, Learning, Leaning Against The Wind

DOI: https://doi.org/10.17016/IFDP.2018.1236r1

PDF: Full Paper

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Last Update: January 09, 2020