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Monetary Policy and Inflation Dynamics in Asset Price Bubbles

February 28, 2013
Daisuke Ikeda*1

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Abstract

This paper integrates an asset price bubble and agency costs in firms' price-setting decisions into a monetary DSGE framework. Amplified by nominal wage rigidities, an asset price bubble causes an inefficiently excessive boom. Inflation, however, remains moderate in the boom, because a loosening in financial tightness lowers the agency costs and adds downward pressure on inflation. Stabilizing inflation makes the excessive boom even excessive in the short run. The optimal monetary policy calls for monetary tightening to restrain the boom at the cost of greater volatility in inflation.

JEL Classifications
E44; E52

Keywords
Optimal monetary policy; Asset price bubbles

I am grateful to Takeshi Kimura for his advice and comments. I would like to thank Wouter Den Haan, Jordi Gali, Vincenzo Quadrini, Masashi Saito and participants of the Bank of Japan seminar, the International Conference on Macroeconomic Modeling in Times of Crisis and the 5th GRIPS International Conference of Macroeconomics and Policy for their comments. The views expressed in this paper are those of the author and should not be interpreted as the official views of the Bank of Japan.

  •   *1 Monetary Affairs Department
    E-mail : daisuke.ikeda@boj.or.jp

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