Monetary Policy and Asset Prices: More Bad News for Benign Neglect

20 Pages Posted: 11 Dec 2007

See all articles by Wolfram Berger

Wolfram Berger

Fernuniversitaet Hagen

Friedrich Kißmer

Fernuniversitaet Hagen

Helmut Wagner

University of Hagen (Fernuniversitaet Hagen)

Abstract

In this paper we explore the optimal policy reaction to boombust cycles in asset prices. Bordo and Jeanne (2002a, b) point to the risks of a reactive strategy that only mitigates the consequences of a crisis if and when it occurs. Acting pre-emptively by rigorously counteracting the build-up of the crisis scenario may be superior in welfare terms. We show that even a purely reactive monetary policy must involve an ex ante response to a possible asset price crash. The reason, however, is not the attempt to avoid real and financial disruption but to react optimally to changes in the private sector's expectations. Furthermore, we find that the welfare losses of a reactive strategy increase when forward-looking expectations are taken into account, while the welfare implications of a proactive strategy do not change.

Suggested Citation

Berger, Wolfram and Kißmer, Friedrich and Wagner, Helmut, Monetary Policy and Asset Prices: More Bad News for Benign Neglect. International Finance, Vol. 10, Issue 1, pp. 1-20, Spring 2007, Available at SSRN: https://ssrn.com/abstract=1062002 or http://dx.doi.org/10.1111/j.1468-2362.2006.00192.x

Wolfram Berger (Contact Author)

Fernuniversitaet Hagen ( email )

Universitätsstrasse 41
Feithstrathe 140
D-58084 Hagen
Germany

Friedrich Kißmer

Fernuniversitaet Hagen

Lehrstuhl Volkswirtschaftslehre
Feithstrathe 140
D-58084 Hagen
Germany

Helmut Wagner

University of Hagen (Fernuniversitaet Hagen) ( email )

Universitätsstrasse 41
Feithstrathe 140
D-58084 Hagen
Germany
011-49-2331-987-2640 (Phone)
011-49-2331-987-391 (Fax)

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