Working Paper（26-010E）Money Illusion and Asset-Price-Targeting Monetary Policy

This paper investigates asset-price-targeting monetary policy in a New Keynesian model with money illusion. Money illusion is introduced as misperceptions of current and expected future inflation. We derive a necessary and sufficient condition for equilibrium determinacy and express it as an extended Taylor principle. In the benchmark case, a policy response to asset prices may weaken determinacy. With current inflation misperception, however, higher inflation can raise dividends and asset prices, making asset-price targeting stabilizing. The results show that the effects of asset-price targeting depend on both nominal rigidities and inflation perceptions.

Keywords: Money Illusion; inflation misperceptions; asset prices; monetary policy

JEL Classifications: E31, E32, E52, D84