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Working Paper
Should central banks lean against changes in asset prices?
How should monetary policy be conducted in the presence of endogenous feedback loops between asset prices, firms? financial health, and economic activity? We reconsider this question in the context of the financial accelerator model and show that, when the level of natural output is inefficient, the optimal monetary policy under commitment leans considerably against movements in asset prices and risk premia. We demonstrate that an endogenous feedback loop is crucial for this result and that price stability is otherwise quasi-optimal absent this feature. We also show that the optimal policy ...
Working Paper
Monetary Policy Response to Oil Price Shocks
How should monetary authorities react to an oil price shock? The New Keynesian literature has concluded that ensuring complete price stability is the optimal thing to do. In contrast, this paper argues that a meaningful trade-off between stabilizing inflation and the welfare relevant output gap arises in a distorted economy once one recognizes (i) that oil (energy) cannot be easily substituted by other factors in the short-run, (ii) that there is no fiscal transfer available to policymakers to neutralize the steady-state distortion due to monopolistic competition, and (iii) that increases in ...