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Asset price bubbles with low interest rates: not all bubbles are alike

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  • Jacopo Bonchi

Abstract

I extend a standard two-period OLG model to investigate the interplay between the risks of a binding zero lower bound and asset price bubbles in a low interest rates environment. The nature of the bubble is crucial when the risk-free real interest rate is low because there is a negative natural interest rate. Bubbles are fully leveraged when they are sustained by borrowers, or they are fully unleveraged when they are sustained by lenders. Leveraged bubbles emerge naturally when there is a negative natural interest rate, and they are more likely to collapse. Unleveraged bubbles appear, in contrast, if the natural rate of interest is extremely low and the probability of the bubble bursting is not extremely high. Both bubbles are more likely to emerge with a high inflation target and will potentially be larger, but only leveraged bubbles substantially mitigate the risk of a zero lower bound episode by raising the natural rate of interest

Suggested Citation

  • Jacopo Bonchi, 2019. "Asset price bubbles with low interest rates: not all bubbles are alike," Bank of Estonia Working Papers wp2019-01, Bank of Estonia, revised 23 Jan 2019.
    • Handle: RePEc:eea:boewps:wp2019-01
    DOI: 10.23656/25045520/012019/0163
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    File URL: http://dx.doi.org/10.23656/25045520/012019/0163
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    Cited by:

    1. Jacopo Bonchi, 2023. "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, vol. 47, pages 186-203, January.
    2. Jacopo Bonchi, 2023. "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, vol. 47, pages 186-203, January.

    More about this item

    Keywords

    zero lower bound; low interest rates; asset price bubbles; inflation target;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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