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Asset Price Bubbles and Monetary Policy

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  • Franklin Allen
  • Douglas Gale

Abstract

Positive and negative asset price bubbles and their relationship to monetary policy are considered. Positive bubbles occur when there is an agency problem between banks and the people they lend money to because the banks cannot observe how the funds are invested. This causes a risk shifting problem and asset prices are bid up above their fundamental. The greater is uncertainty concerning monetary policy and the amount of aggregate credit the greater is the bubble. Negative bubbles can occur when there is a banking crisis that forces banks to simultaneously liquidate assets. Asset prices fall below their fundamental because of a lack of liquidity. If the central bank provides a monetary injection this negative bubble can be prevented.

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File URL: http://fic.wharton.upenn.edu/fic/papers/01/0126.pdf
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Bibliographic Info

Paper provided by Wharton School Center for Financial Institutions, University of Pennsylvania in its series Center for Financial Institutions Working Papers with number 01-26.

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Date of creation: May 2000
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Handle: RePEc:wop:pennin:01-26

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Cited by:
  1. Marcel Canoy & Machiel van Dijk & Jan Lemmen & Ruud de Mooij & Jürgen Weigand, 2001. "Competition and stability in banking," CPB Document 15, CPB Netherlands Bureau for Economic Policy Analysis.
  2. Gadi Barlevy, 2011. "A leverage-based model of speculative bubbles," Working Paper Series WP-2011-07, Federal Reserve Bank of Chicago.
  3. Topi, Jukka & Vilmunen, Jouko, 2001. "Transmission of monetary policy shocks in Finland: evidence from bank level data on loans," Working Paper Series 0100, European Central Bank.
  4. Siklos, Pierre L. & Bohl, Martin T. & Werner, Thomas, 2003. "Did the Bundesbank React to Stock Price Movements?," Discussion Paper Series 1: Economic Studies 2003,14, Deutsche Bundesbank, Research Centre.
  5. Bilge Kagan Ozdemir, 2009. "Banking Sector Stability During The Process Of Euro Adoption," Anadolu University Journal of Social Sciences, Anadolu University, vol. 9(1), pages 123-1236, June.

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