This paper analyses the relationship between monetary policy and asset prices using a structural
rational expectations model that allows for the effect of asset prices on aggregate demand. We assume that
asset prices follow a partial adjustment mechanism whereas they are positively affected by past changes,
thus allowing for ‘momentum trading’, while at the same time we allow for reversion towards
fundamentals. We then conduct stochastic simulations using two alternative monetary policy rules,
inflation-forecast targeting and the standard Taylor rule. The results indicate that, under both rules, interest
rate setting that takes into account asset price misalignments leads to lower overall macroeconomic
volatility, as measured by the postulated loss function of the central bank
