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New Perspectives on Asset Price Bubbles$
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Douglas D. Evanoff, George G. Kaufman, and A. G. Malliaris

Print publication date: 2012

Print ISBN-13: 9780199844333

Published to Oxford Scholarship Online: April 2015

DOI: 10.1093/acprof:osobl/9780199844333.001.0001

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PRINTED FROM OXFORD SCHOLARSHIP ONLINE (oxford.universitypressscholarship.com). (c) Copyright Oxford University Press, 2021. All Rights Reserved. An individual user may print out a PDF of a single chapter of a monograph in OSO for personal use. date: 25 July 2021

Monetary Policy and Stock Market Booms

Monetary Policy and Stock Market Booms

(p.353) Chapter 14 Monetary Policy and Stock Market Booms
New Perspectives on Asset Price Bubbles

Lawrence J. Christiano

Cosmin Ilut

Roberto Motto

Massimo Rostagno

Oxford University Press

This chapter examines some of the traditional views on appropriate monetary policy and its relationship with stock market booms. Using historical data and model simulations for eighteen boom periods in the United States, it considers the interaction between monetary policy and asset price volatility and its implications for the stock market. It also asks whether monetary policy is partly responsible for stock market booms and whether it should actively seek to stabilize such booms. The chapter shows that if inflation is low during stock market bubbles, an interest rate rule that narrowly targets inflation actually destabilizes asset markets and the macroeconomy. By setting interest rates to target low inflation, central banks are actually setting real rates below the natural rate, giving rise to asset price bubbles. To reduce volatility in asset prices and the real economy, credit growth must be taken into account in the interest rate targeting rule.

Keywords:   monetary policy, stock market booms, asset price volatility, stock market, inflation, macroeconomy, interest rates, central bank, asset price bubbles, credit growth

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