This paper argues that nonlinear adjustment may provide a better explanation of fluctuations in the consumption-wealth ratio. The nonlinearity is captured by a Markov-switching vector error-correction model that allows the dynamics of the relationship to differ across regimes. Estimation of the...

We analyse the monetary policy implications of boom-bust cycles in asset prices using a Markov-switching rational expectations model. In our simulations, when a bubble bursts, the Taylor rule fails to achieve a soft landing, contrary to the optimal policy.