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Bubbles and Central Banks: Historical Perspectives

Listed author(s):
  • Markus K. Brunnermeier

    ()

    (Princeton University)

  • Isabel Schnabel

This paper reviews some of the most prominent asset price bubbles from the past 400 years and documents how central banks (or other institutions) reacted to those bubbles. The historical evidence suggests that the emergence of bubbles is often preceded or accompanied by an expansionary monetary policy, lending booms, capital inflows, and financial innovation or deregulation. We find that the severity of the economic crisis following the bursting of a bubble is less linked to the type of asset than to the financing of the bubble – crises are most severe when they are accompanied by a lending boom, high leverage of market players, and when financial institutions themselves are participating in the buying frenzy. Past experience also suggests that a purely passive “cleaning up the mess” stance towards inflating bubbles in many cases is costly. At the same time, while interest - rate leaning policies and macroprudential tools can and sometimes have helped to deflate bubbles and mitigate the associated economic crises, the correct implementation of such proactive policy approaches remains fraught with difficulties.

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File URL: http://www.macro.economics.uni-mainz.de/RePEc/pdf/Discussion_Paper_1411.pdf
File Function: First version, 2014
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Paper provided by Gutenberg School of Management and Economics, Johannes Gutenberg-Universität Mainz in its series Working Papers with number 1411.

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Length: 30 pages
Date of creation: 31 Oct 2014
Date of revision: 31 Oct 2014
Handle: RePEc:jgu:wpaper:1411
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