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Monetary Policy and Asset Price Bubbles: New Developments

Paper Session

Saturday, Jan. 6, 2018 2:30 PM - 4:30 PM

Pennsylvania Convention Center, 201-A
Hosted By: American Economic Association
  • Chair: Emmanuel Farhi, Harvard University

On Interest Rate Policy and Asset Bubbles

Gadi Barlevy
,
Federal Reserve Bank of Chicago
Franklin Allen
,
University of Pennsylvania
Douglas Gale
,
New York University

Abstract

In a provocative paper, Gali (2014), showed that a policymaker who raises interest rates because of concerns about a bubble will paradoxically make the bubble bigger. In this paper, we argue Gali’s framework abstracts from the possibility that a policymaker who raises rates might crowd out resources that would have otherwise been spent on the bubble. We show that when we modify Gali’s model to allow for this possibility, interventions that lead to higher interest rates can dampen bubbles. However, even if raising rates effectively dampens bubbles, such an intervention is not Pareto improving in the modified version of Gali’s model we analyze. We then show that if we modify the model so that it can generate the type of credit-driven bubbles policymakers worry about, raising rates may still be effective against bubbles, and that there may be scope for such interventions to make society better off.

Risky Bubbles, Public Debt and Monetary Policies

Daisuke Ikeda
,
Bank of England
Tomohiro Hirano
,
University of Tokyo
Toan Phan
,
Federal Reserve Bank of Richmond

Abstract

We analyze the effects of monetary policies in a neoclassical growth model with nominal rigidities and stochastic rational bubbles, where output is determined by capital accumulation. We show that the expectations of the bubble's bursting risk and of the monetary policy stance after the bubble collapses affect the steady state and dynamics of bubbles. A conventional `leaning-against-the-wind' monetary policy of a surprise rise in the nominal interest rate decreases the bubble asset price and has typical tightening effects on output and inflation. An unconventional monetary policy of purchasing government bonds has different effects on bubbles, output and
inflation, depending on whether bubbles are small or large. The model provides new insights on interactions between monetary policy, safe government debt and risky bubbles.

Bubbly Recessions

Toan Phan
,
Federal Reserve Bank of Richmond
Siddhartha Biswas
,
University of North Carolina
Andrew Hanson
,
University of North Carolina

Abstract

We develop a tractable rational bubble model with downward nominal wage rigidity and a zero lower bound on the nominal interest rate. We show that the collapse of a large bubble causes an undershooting of the real interest rate, which could push the economy into a persistent liquidity trap with involuntary unemployment and depressed economic activities.

Monetary Policy and Bubbles in a New Keynesian Model with Overlapping Generations

Jordi Gali
,
Pompeu Fabra University

Abstract

I develop an extension of the basic New Keynesian model with overlapping generations of Önitely-lived agents. In contrast with the standard model, the proposed framework allows for the existence of rational expectations equilibria featuring asset price bubbles. I examine the conditions under which bubbly equilibria may emerge and the implications for the design of monetary policy. Monetary policies that lean against the bubble are shown to be potentially destabilizing, and likely to be dominated by ináation targeting policies.
Discussant(s)
Tomoyuki Nakajima
,
University of Tokyo
Alexander Wolman
,
Federal Reserve Bank of Richmond
Vladimir Asriyan
,
Pompeu Fabra University
Emmanuel Farhi
,
Harvard University
JEL Classifications
  • E4 - Money and Interest Rates
  • E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit