Welfare analysis of non-fundamental asset price and investment shocks: Implications for monetary policy

Using a sticky price-wage model with capital accumulation and adjustment costs, this paper analyses the welfare effects of non-fundamental asset price and investment fluctuations for the representative household. The welfare effect depends strongly on the steady state level around which the economy is fluctuating. If output is below the first best competitive equilibirum because of the existence of markups in a monopolisitc competitive environment, asset price booms and the resulting positive investment and demand effects move the economy in the direction of the efficient output and can therefore be welfare improving. In such a case, optimal monetary policy will no longer be characterised by a symmetric response to inflation and output movements around the steady state, but will typically need to adjust asymmetrically