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Board of Governors of the Federal Reserve System (U.S.)
International Finance Discussion Papers
Asset Price Learning and Optimal Monetary Policy
Colin Caines
Fabian Winkler
Abstract

We characterize optimal monetary policy when agents are learning about endogenous asset prices. Boundedly rational expectations induce inefficient equilibrium asset price fluctuations which translate into inefficient aggregate demand fluctuations. We find that the optimal policy raises interest rates when expected capital gains, and the level of current asset prices, is high. The optimal policy does not eliminate deviations of asset prices from their fundamental value. When monetary policymakers are information-constrained, optimal policy can be reasonably approximated by simple interest rate rules that respond to capital gains. Our results are robust to a wide range of belief specifications as well as to the inclusion of an investment channel.


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Colin Caines & Fabian Winkler, Asset Price Learning and Optimal Monetary Policy, Board of Governors of the Federal Reserve System (U.S.), International Finance Discussion Papers 1236, 21 Aug 2018.
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Keywords: Optimal monetary policy ; Natural real Interest rate ; Learning ; Asset price volatility ; Leaning against the wind
DOI: 10.17016/IFDP.2018.1236
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