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Rational Bubbles and Macroeconomic Fluctuations. The(De-)Stabilizing Role of Monetary Policy

We are interested in the occurrence of expectation-driven fluctuations of a rational bubble and the (de-)stabilizing role of monetary policy. Our explanation of fluctuations is based on credit market imperfections. For this purpose, we consider an overlapping generations exchange economy where households realize a portfolio choice between money and bubble. Money is held because of a partial cash-in-advance constraint affected by the bubble. Bubble acts as a store of value, but also as a collateral. Indeed, a higher value of the bubble implies a higher amount of collateral, which, in turn, reduces the need of cash, and thus increases consumption purchased on credit. Under these credit market features, expectation-driven fluctuations and the multiplicity of steady-states occur, in particular for arbitrarily small market distortions. Investing the stabilizing role of monetary policy, we show that when the monetary policy rule depends on expected inflation only, a more active rule stabilizes only if collateral has a large effect on consumption financed on credit. Finally, we enrich this rule by including asset prices. A policy which depends on asset prices can stabilize whatever the effect of collateral and can also rule out the multiplicity of steady states. More generally, this paper emphasizes the key role of consumers' credit market imperfections to explain bubble fluctuations and exhibits the stabilizing power of monetary rules including asset prices.

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Paper provided by Aix-Marseille School of Economics, Marseille, France in its series AMSE Working Papers with number 1207.

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Length: 36 pages
Date of creation: 23 Mar 2012
Date of revision: 23 Mar 2012
Handle: RePEc:aim:wpaimx:1207
Contact details of provider: Web page: http://www.amse-aixmarseille.fr/en

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