The Optimal Monetary Policy Instrument , Inflation vs . Asset Price Targeting , and Financial Stability ∗

This paper assesses the choice of policy instruments for crisis management and prevention and whether Central Banks should target consumer and asset prices to maintain financial stability. Our results suggest that the interest rate is preferable to the money supply instrument because in times of financial distress the Central Bank automatically satisfies the increased demand for money, and that monetary policy aimed at stabilizing consumer inflation, but not asset price inflation, can promote financial instability. However, we also show that Central Banks' financial stability objective should be primarily achieved by regulatory measures.