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Monetary Policy for a Bubbly World

Author

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  • Vladimir Asriyan
  • Luca Fornaro
  • Alberto Martin
  • Jaume Ventura

Abstract

We propose a model of money, credit and bubbles, and use it to study the role of monetary policy in managing asset bubbles. In this model, bubbles pop up and burst, generating fluctuations in credit, investment and output. Two key insights emerge from the analysis. First, the growth rate of bubbles, which is driven by agents’ expectations, can be set in real or in nominal terms. This gives rise to a novel channel of monetary policy, as changes in the inflation rate affect the real growth rate of bubbles and their effect on economic activity. Crucially, this channel does not rely on contract incompleteness or price rigidities. Second, there is a natural limit on monetary policy’s ability to control bubbles: the zero-lower bound. When a bubble crashes, the economy may enter into a liquidity trap, a regime in which agents shift their portfolios away from bubbles - and the credit that they sustain - to money, reducing intermediation, investment and growth. We explore the implications of the model for the conduct of “conventional” and “unconventional” monetary policy, and we use the model to provide a broad interpretation of salient macroeconomic facts of the last two decades.

Suggested Citation

  • Vladimir Asriyan & Luca Fornaro & Alberto Martin & Jaume Ventura, 2016. "Monetary Policy for a Bubbly World," NBER Working Papers 22639, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:22639
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    Citations

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    Cited by:

    1. Siddhartha Biswas & Andrew Hanson & Toan Phan, 2018. "Bubbly Recessions," Working Paper 18-5, Federal Reserve Bank of Richmond, revised 22 Feb 2018.
    2. 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.
    3. Gianluca Benigno & Luca Fornaro, 2018. "Stagnation Traps," Review of Economic Studies, Oxford University Press, vol. 85(3), pages 1425-1470.
    4. 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.
    5. Saki Bigio & Eduardo Zilberman, 2020. "Speculation-Driven Business Cycles," Working Papers Central Bank of Chile 865, Central Bank of Chile.
    6. Sebastian Di Tella, 2018. "A Neoclassical Theory of Liquidity Traps," 2018 Meeting Papers 96, Society for Economic Dynamics.
    7. 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.
    8. Sushant Acharya & Keshav Dogra, . "The side effects of safe asset creation," Staff Reports, Federal Reserve Bank of New York.
    9. Jean-Baptiste Michau & Yoshiyasu Ono & Matthias Schlegl, 2018. "Wealth Preference and Rational Bubbles," CESifo Working Paper Series 7148, CESifo Group Munich.
    10. Jean-Baptiste Michau & Yoshiyasu Ono & Matthias Schlegl, 2018. "Wealth Preference and Rational Bubbles," CESifo Working Paper Series 7148, CESifo Group Munich.
    11. Edouard Schaal & Mathieu Taschereau-Dumouchel, 2020. "Herding cycles," Economics Working Papers 1714, Department of Economics and Business, Universitat Pompeu Fabra.
    12. Pengfei Wang & Jianjun Miao & Feng Dong, 2017. "Asset Bubbles and Monetary Policy," 2017 Meeting Papers 205, Society for Economic Dynamics.
    13. Edouard Schaal & Mathieu Taschereau-Dumouchel, 2020. "Herding cycles," Economics Working Papers 1714, Department of Economics and Business, Universitat Pompeu Fabra.
    14. Haozhou Tang, 2018. "Asset Price Bubbles and the Distribution of Firms," 2018 Meeting Papers 362, Society for Economic Dynamics.
    15. Hanson, Andrew & Phan, Toan, 2017. "Bubbles, wage rigidity, and persistent slumps," Economics Letters, Elsevier, vol. 151(C), pages 66-70.
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    More about this item

    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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