Publication

This paper discusses the question of whether central banks should react to stock price developments and influence asset prices so as to prevent bubbles and crashes from occurring. The author talks about the difficulty of identifying bubbles before they happen and the causal relation between asset prices and bubbles and crashes. He then proposes a model to answer the question of whether a central bank can improve macroeconomic stability by reacting to asset price movements. He finds that a critical element is the degree of credibility of the inflation-targeting regime.