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Monetary Policy for a Bubbly World

Author

Listed:
  • Vladimir Asriyan
  • Luca Fornaro
  • Alberto Martín
  • Jaume Ventura

Abstract

What is the role of monetary policy in a bubbly world? To address this question, we study an economy in which financial frictions limit the supply of assets. The ensuing scarcity generates a demand for "unbacked" assets, i.e., assets that are backed only by the expectation of their future value. We consider two types of unbacked assets: bubbles, which are created by the private sector, and money, which is created by the central bank. Bubbles and money share many features, but they also differ in two crucial respects. First, while the rents from the creation of bubbles accrue to entrepreneurs and foster investment, the rents from money creation accrue to the central bank. Second, while bubbles are driven by market psychology, and can rise and fall according to the whims of the market, money is under the control of the central bank. We characterize the optimal monetary policy and show that, through its ability to supply assets, monetary policy plays a key role in the bubbly world. The model sheds light on the recent expansion of central bank liabilities in response to the bursting of bubbles.

Suggested Citation

  • Vladimir Asriyan & Luca Fornaro & Alberto Martín & Jaume Ventura, 2016. "Monetary Policy for a Bubbly World," Working Papers 921, Barcelona Graduate School of Economics.
  • Handle: RePEc:bge:wpaper:921
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Gianluca Benigno & Luca Fornaro, 2018. "Stagnation Traps," Review of Economic Studies, Oxford University Press, vol. 85(3), pages 1425-1470.
    2. Siddhartha Biswas & Andrew Hanson & Toan Phan, 2018. "Bubbly Recessions," Working Paper 18-5, Federal Reserve Bank of Richmond, revised 22 Feb 2018.
    3. Hanson, Andrew & Phan, Toan, 2017. "Bubbles, wage rigidity, and persistent slumps," Economics Letters, Elsevier, vol. 151(C), pages 66-70.
    4. Alberto Martin & Jaume Ventura, 2018. "The Macroeconomics of Rational Bubbles: A User's Guide," Annual Review of Economics, Annual Reviews, vol. 10(1), pages 505-539, August.
    5. Edouard Schaal & Mathieu Taschereau-Dumouchel, 2020. "Herding cycles," Economics Working Papers 1714, Department of Economics and Business, Universitat Pompeu Fabra.
    6. Pengfei Wang & Jianjun Miao & Feng Dong, 2017. "Asset Bubbles and Monetary Policy," 2017 Meeting Papers 205, Society for Economic Dynamics.
    7. Jordi Galí, 2016. "Monetary policy and bubbles in a new Keynesian model with overlapping generations," Economics Working Papers 1561, Department of Economics and Business, Universitat Pompeu Fabra, revised Jan 2020.
    8. Saki Bigio & Eduardo Zilberman, 2020. "Speculation-Driven Business Cycles," Working Papers Central Bank of Chile 865, Central Bank of Chile.
    9. Sebastian Di Tella, 2018. "A Neoclassical Theory of Liquidity Traps," 2018 Meeting Papers 96, Society for Economic Dynamics.
    10. Gauti B. Eggertsson & Neil R. Mehrotra & Jacob A. Robbins, 2019. "A Model of Secular Stagnation: Theory and Quantitative Evaluation," American Economic Journal: Macroeconomics, American Economic Association, vol. 11(1), pages 1-48, January.
    11. Keshav Dogra & Sushant Acharya, 2017. "The Side Effects of Safe Asset Creation," 2017 Meeting Papers 1453, Society for Economic Dynamics.
    12. Jean-Baptiste Michau & Yoshiyasu Ono & Matthias Schlegl, 2018. "Wealth Preference and Rational Bubbles," CESifo Working Paper Series 7148, CESifo Group Munich.
    13. Gadi Barlevy, 2018. "Bridging Between Policymakers’ and Economists’ Views on Bubbles," Economic Perspectives, Federal Reserve Bank of Chicago, issue 4, pages 1-21.
    14. Edouard Schaal & Mathieu Taschereau-Dumouchel, 2020. "Herding cycles," Economics Working Papers 1714, Department of Economics and Business, Universitat Pompeu Fabra.
    15. Jean-Baptiste Michau & Yoshiyasu Ono & Matthias Schlegl, 2018. "Wealth Preference and Rational Bubbles," CESifo Working Paper Series 7148, CESifo Group Munich.
    16. Haozhou Tang, 2018. "Asset Price Bubbles and the Distribution of Firms," 2018 Meeting Papers 362, Society for Economic Dynamics.

    More about this item

    Keywords

    Bubbles; monetary policy; liquidity; traps; financial frictions;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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