And as I will argue below, the same conclusion holds as regards the other possible triggers for deflation – asset price declines or financial sector fragility. Overall, therefore, I am confident that Europe will not experience a period of persistent deflation – and the associated problems that this could cause. I can also assure you that we are aware of the risk.
To discuss the monetary policy responses to a bubble, it matters a great deal how to understand the transmission mechanism of monetary policy. The recent monetary policy analysis, based on new Keynesian macroeconomics, explores optimal monetary policy to stabilize inflation and output.