This paper analyses the relationship between monetary policy and asset prices in the context of
optimal policy rules. The transmission mechanism is represented by a linearized rational expectations
model augmented for the effect of asset prices on aggregate demand. Stabilization objectives are
represented by a discounted quadratic loss function penalizing inflation and output gap volatility. Asset
prices are allowed to deviate from their intrinsic value since they may be positively affected by past price
changes. We find that in the presence of wealth effects and inefficient markets, asset price misalignments
from their fundamentals should be included in the optimal interest rate reaction function