Monetary policy, doubts and asset prices

Asset prices and the equity premium might reflect doubts and pessimism. Introducing these features in an otherwise standard New-Keynesian model changes in a quite substantial way its normative conclusions. First, following productivity shocks, optimal policy should be very accommodative even to the point to inflate the equity premium. Second, asset-price movements improve the inflation-output trade-off so that average output can rise without increasing much average inflation. Finally, a strict inflation-targeting policy is dominated by more flexible inflationtargeting policies which increase the comovements between inflation, asset prices and output growth. ∗Pierpaolo Benigno acknowledges financial support from an ERC Starting Independent Grant.