Monetary policy rules, asset prices and adaptive learning

• We model monetary policy response to asset prices in an adaptive learning context.
• Determinacy and E-Stability criteria are analyzed for two types of interest rate rules.
• Responding to asset price is not optimal considering instrumental interest rate rules.
• The result holds for heterogeneous beliefs and optimal monetary policy.

Following the damaging real effects of asset price fluctuations over the recent financial crisis, the debate on the appropriate role of such prices in a monetary policy context has gained renewed attention. This paper argues that a direct monetary policy response to asset prices is not desirable under common instrumental rate rules. To illustrate this point, we build an adaptive learning model, that extends existing learning models in monetary policy, most notably, Bullard and Mitra (2002). The result remains valid in a context with heterogeneous beliefs and is robust to an optimal monetary policy rule including a weight on asset prices.