On Speculative Frenzies and Price Stability

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Abstract: This paper examines whether tasking central banks with leaning against asset booms can conflict with their goal of maintaining price stability. The paper embeds the Harrison and Kreps (1978) model of speculative trade in a monetary model based on Rocheteau, Weil, and Wong (2019). I show that a disagreement shock which leads to a speculative asset boom is associated with an output boom but low inflation. This suggests a central bank that aims to reduce liquidity during an asset boom would be forced to do so at a time of low inflation. The model can explain why monetary easing may sometimes appear to generate inflation in asset prices but not goods prices. The predictions of the model also seem consistent with some of the available evidence on inflation and asset booms.

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