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American Economic Review: Vol. 104 No. 3 (March 2014)

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Monetary Policy and Rational Asset Price Bubbles

Article Citation

Galí, Jordi. 2014. "Monetary Policy and Rational Asset Price Bubbles." American Economic Review, 104(3): 721-52.

DOI: 10.1257/aer.104.3.721

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.

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Authors

Galí, Jordi (CREI, Barcelona and U Pompeu Fabra)

JEL Classifications

E13: General Aggregative Models: Neoclassical
E32: Business Fluctuations; Cycles
E44: Financial Markets and the Macroeconomy
E52: Monetary Policy
G12: Asset Pricing; Trading Volume; Bond Interest Rates


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