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Monetary Policy for a Bubbly World

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  • Asriyan, Vladimir
  • Fornaro, Luca
  • Martín, Alberto
  • Ventura, Jaume

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.

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  • Asriyan, Vladimir & Fornaro, Luca & Martín, Alberto & Ventura, Jaume, 2019. "Monetary Policy for a Bubbly World," CEPR Discussion Papers 13803, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:13803
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    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Monetary policy for a bubbly world
      by Christian Zimmermann in NEP-DGE blog on 2016-10-21 18:53:58

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    Cited by:

    1. 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.
    2. 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.
    3. Saki Bigio & Eduardo Zilberman, 2020. "Speculation-Driven Business Cycles," Working Papers Central Bank of Chile 865, Central Bank of Chile.
    4. Sebastian Di Tella, 2018. "A Neoclassical Theory of Liquidity Traps," 2018 Meeting Papers 96, Society for Economic Dynamics.
    5. 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.
    6. Keshav Dogra & Sushant Acharya, 2017. "The Side Effects of Safe Asset Creation," 2017 Meeting Papers 1453, Society for Economic Dynamics.
    7. Francisco Queiros, 2018. "Asset Bubbles and Product Market Competition," 2018 Meeting Papers 462, Society for Economic Dynamics.
    8. Gianluca Benigno & Luca Fornaro, 2018. "Stagnation Traps," Review of Economic Studies, Oxford University Press, vol. 85(3), pages 1425-1470.
    9. Edouard Schaal & Mathieu Taschereau-Dumouchel, 2020. "Herding Cycles," Working Papers 1166, Barcelona School of Economics.
    10. Jacopo Bonchi, 2020. "Natural Interest Rate and Asset Price Bubbles: How Bubbles Counteract Low Interest Rates," Working Papers 3/20, Sapienza University of Rome, DISS.
    11. Laura Nowzohour & Livio Stracca, 2020. "More Than A Feeling: Confidence, Uncertainty, And Macroeconomic Fluctuations," Journal of Economic Surveys, Wiley Blackwell, vol. 34(4), pages 691-726, September.
    12. Siddhartha Biswas & Andrew Hanson & Toan Phan, 2020. "Bubbly Recessions," American Economic Journal: Macroeconomics, American Economic Association, vol. 12(4), pages 33-70, October.
    13. Hanson, Andrew & Phan, Toan, 2017. "Bubbles, wage rigidity, and persistent slumps," Economics Letters, Elsevier, vol. 151(C), pages 66-70.
    14. Barthelemy, Jean & Mengus, Eric & Plantin, Guillaume, 2019. "Public Liquidity Demand and Central Bank Independence," CEPR Discussion Papers 14160, C.E.P.R. Discussion Papers.
    15. Barthelemy, Jean & Mengus, Eric & Plantin, Guillaume, 2021. "The Central Bank, the Treasury, or the Market: Which One Determines the Price Level?," CEPR Discussion Papers 16679, C.E.P.R. Discussion Papers.
    16. Jacopo Bonchi, . "Asset Price Bubbles and Monetary Policy: Revisiting the Nexus at the Zero Lower Bound," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics.
    17. Jean-Baptiste Michau & Yoshiyasu Ono & Matthias Schlegl, 2018. "Wealth Preference and Rational Bubbles," ISER Discussion Paper 1035, Institute of Social and Economic Research, Osaka University.
    18. Feng Dong & Jianjun Miao & Pengfei Wang, 2020. "Asset Bubbles and Monetary Policy," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 37, pages 68-98, August.
    19. Haozhou Tang, 2018. "Asset Price Bubbles and the Distribution of Firms," 2018 Meeting Papers 362, Society for Economic Dynamics.
    20. Zoë Venter, 2020. "The Interaction Between Conventional Monetary Policy and Financial Stability: Chile, Colombia, Japan, Portugal and the UK," Comparative Economic Studies, Palgrave Macmillan;Association for Comparative Economic Studies, vol. 62(3), pages 521-554, September.
    21. Donato Masciandaro, 2018. "Central Banking and Macroeconomic Ideas: Economics, Politics and History," BAFFI CAREFIN Working Papers 1858, BAFFI CAREFIN, Centre for Applied Research on International Markets Banking Finance and Regulation, Universita' Bocconi, Milano, Italy.
    22. Gadi Barlevy, 2018. "Bridging Between Policymakers’ and Economists’ Views on Bubbles," Economic Perspectives, Federal Reserve Bank of Chicago, issue 4, pages 1-21.

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    More about this item

    Keywords

    bubbles; Financial Frictions; liquidity trap; Optimal monetary policy;
    All these keywords.

    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
    • O40 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - General

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