Monetary policy and asset prices : when cleaning up hits the Zero Lower Bound

Berger, Wolfram GND; Kißmer, Friedrich GND

This study explores the role of the zero lower bound (ZLB) for optimal monetary policy reactions to boom–bust cycles in housing prices. Recently, convincing evidence has been presented that the recession in the wake of the recent financial crisis resulted primarily from an overly levered housing sector that was forced to deleverage and cut consumption spending when faced with collapsing housing prices. Following this interpretation it is argued that, as opposed to the consensus view on monetary policy in the vicinity of the ZLB, optimal monetary policy may involve an interest rate increase if the ZLB threatens to become a binding constraint in the aftermath of an asset price bust. This result delivers arguments to advocate a – in the previous literature less favored – pre-emptive tightening policy in an asset price boom. It is also shown that the actual policy decision that central bankers face is not whether to act preemptively when facing a potentially costly asset price boom but rather in which direction interest rates should move.

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Berger, Wolfram / Kißmer, Friedrich: Monetary policy and asset prices. when cleaning up hits the Zero Lower Bound. Hagen 2013. FernUniversität in Hagen.

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