Asset-Price Misalignments and Monetary Policy: How Flexible Should Inflation-Targeting Regimes Be?

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The authors analyze the extent to which inflation-targeting frameworks should incorporate flexibility in order to respond to asset-price misalignments and other atypical events. They examine the costs and benefits of adding flexibility to the Bank's current inflation-targeting framework, and conclude that maintaining low and stable consumer price inflation is the best contribution that monetary policy can make to promoting economic and financial stability, although some flexibility in the target horizon may allow monetary policy to deal appropriately with asset-price bubbles and other atypical events. The authors suggest that monetary policy may, in principle, be better able to maintain low and stable consumer price inflation by leaning against an asset-price bubble (even though it may mean that inflation deviates longer than usual from its target), when such an event is well identified and likely to have significant real economic effects. This circumstance is likely to be rare in practice, however, because economists are far from being able to determine consistently and reliably when leaning against a particular bubble is likely to be successful. The authors also describe ongoing Bank research to better understand the transmission of asset prices to the real economy and the interaction between asset prices and optimal monetary policy.