Should Monetary Policy Respond To Asset Price Bubbles? Revisiting the Debate

Recent events have highlighted the importance of asset prices to central bank decisions. We argue that, in response to asset price bubbles, central banks should ‘lean against the wind’ (LATW hereafter). Even if the bubbles themselves are not significantly affected by LATW, macroeconomic performance can be improved if monetary policy reacts to asset price misalignments over and above the reaction to fixed horizon inflation forecasts. In addition, it might reduce the probability of bubbles arising at all. This article restates the case for LATW, and reviews the debate. In particular I respond to various criticisms that have been made against LATW and briefly consider alternative policies designed to make the financial system less cyclical.