Asset Price Booms and Macroeconomic Policy: a Risk-Shifting Approach

This paper uses risk-shifting models to analyze some potential policy responses to asset price booms and bubbles. We argue that the presence of risk shifting can generate many of the features of such booms and so is a reasonable framework to explore these issues. Our analysis offers several insights. First, we find that determining whether there is indeed a bubble in asset markets is unimportant, since risk-shifting leads to the same inefficiencies regardless of whether it gives rise to a bubble or not. Second, while risk shifting offers a reason for intervention, we find the leading proposals for interventions against booms have ambiguous welfare implications in our model. Specifically, we show tighter monetary policy may exacerbate some inefficiencies due to risk shifting even as it mitigates others, and that leverage restrictions may fan asset prices and exacerbate excessive leverage rather than curb it.