Monetary Policy and Controlling Asset Bubbles
A great concern is whether there is any means of monetary policy that works for the “leaning against the wind” policy in the bubbly economy. This paper explores the scope for monetary policy that can control bubbles within the framework of the stochastic version of overlapping-generations model with rational bubbles. The policy that raises the cost of external finance, could be identified as monetary tightening, represses the boom, but appreciate bubbles. In contrast, an open market operation using public bonds is conductive as the “leaning against the wild” policy. Selling public bonds in the open market by the central bank raises the interest rate, represses the boom, and depreciates bubbles. In conducting monetary tightening, the central bank faces the tradeoff between the loss from killing the boom and the gain from lessening the loss of the bursting of bubbles.