Abstract
Considers whether central banks can improve their effectiveness--and lessen the likelihood of economic instability--by explicitly taking asset price shifts into account when setting monetary policy. Presents a prima facie case for why central banks ought to be able to improve macroeconomic performance by including asset price developments directly in their policy formulation and uses model simulations to test the robustness of the arguments. Considers the problem of measuring misalignments and identifying bubbles and assesses the implications for the attempt to incorporate information from asset markets into the design of monetary policy. Proposes how asset prices could be incorporated in an inflation-targeting framework for monetary policy. Draws lessons from historical episodes from the United States, Japan, and Hong Kong in which the central bank reacted to asset price misalignments. Reports on a survey of market participants that checks whether central bank policy is perceived to be reacting symmetrically to asset price increases and decreases. Examines whether asset prices ought to be included directly in measures of inflation and whether asset prices can be used to improve forecasts of future inflation. Coauthors are Hans Genberg, John Lipsky, and Sushil Wadhwani. Cecchetti is at Ohio State University. No index.