Optimal Monetary Policy during Boom-Bust Cycles: The Impact of Globalization

Abstract

During boom-bust cycles in asset prices, monetary policy has the choice between two strategies: the proactive strategy of curbing asset price inflation and preventing a bust-induced credit crunch and the reactive strategy of loosening monetary policy conditions during the boom phase. We show that globalization makes the reactive strategy the favorable option in all situations, relatively to the proactive strategy. However, when employing an absolute comparison of calculating both strategies’ losses, the proactive strategy is the optimal choice in exceptional circumstances.