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Asset Price Booms and Macroeconomic Policy: a Risk-Shifting Approach

Author

Listed:
  • Franklin Allen

    (University of Pennsylvania)

  • Douglas Gale

    (New York University)

  • Gadi Barlevy

    (Federal Reserve Bank of Chicago)

Abstract

This paper uses risk-shifting models to analyze some potential policy responses to asset price booms and bubbles. We argue that the presence of risk shifting can generate many of the features of such booms and so is a reasonable framework to explore these issues. Our analysis offers several insights. First, we find that determining whether there is indeed a bubble in asset markets is unimportant, since risk-shifting leads to the same inefficiencies regardless of whether it gives rise to a bubble or not. Second, while risk shifting offers a reason for intervention, we find the leading proposals for interventions against booms have ambiguous welfare implications in our model. Specifically, we show tighter monetary policy may exacerbate some inefficiencies due to risk shifting even as it mitigates others, and that leverage restrictions may fan asset prices and exacerbate excessive leverage rather than curb it.

Suggested Citation

  • Franklin Allen & Douglas Gale & Gadi Barlevy, 2019. "Asset Price Booms and Macroeconomic Policy: a Risk-Shifting Approach," 2019 Meeting Papers 587, Society for Economic Dynamics.
  • Handle: RePEc:red:sed019:587
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    File URL: https://economicdynamics.org/meetpapers/2019/paper_587.pdf
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    References listed on IDEAS

    as
    1. Barlevy, Gadi, 2014. "A leverage-based model of speculative bubbles," Journal of Economic Theory, Elsevier, vol. 153(C), pages 459-505.
    2. John H. Cochrane, 2011. "Determinacy and Identification with Taylor Rules," Journal of Political Economy, University of Chicago Press, vol. 119(3), pages 565-615.
    3. Gilchrist, Simon & Leahy, John V., 2002. "Monetary policy and asset prices," Journal of Monetary Economics, Elsevier, vol. 49(1), pages 75-97, January.
    4. Douglas Gale, 1996. "Equilibria and Pareto optima of markets with adverse selection (*)," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 7(2), pages 207-235.
    5. Grossman, Gene M. & Yanagawa, Noriyuki, 1993. "Asset bubbles and endogenous growth," Journal of Monetary Economics, Elsevier, vol. 31(1), pages 3-19, February.
    6. Simon Dubecq & Benoit Mojon & Xavier Ragot, 2015. "Risk Shifting with Fuzzy Capital Constraints," International Journal of Central Banking, International Journal of Central Banking, vol. 11(1), pages 71-101, January.
    7. Simon Dubecq & Benoît Mojon & Xavier Ragot, 2015. "Risk Shifting with Fuzzy Capital Constraints," Post-Print halshs-01157527, HAL.
    8. Jordi Gal?, 2014. "Monetary Policy and Rational Asset Price Bubbles," American Economic Review, American Economic Association, vol. 104(3), pages 721-752, March.
    9. Klaus Adam, 2003. "Learning and Equilibrium Selection in a Monetary Overlapping Generations Model with Sticky Prices," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 887-907.
    10. Dow, James & Han, Jungsuk, 2015. "Contractual incompleteness, limited liability and asset price bubbles," Journal of Financial Economics, Elsevier, vol. 116(2), pages 383-409.
    11. Simon Dubecq & Benoit Mojon & Xavier Ragot, 2015. "Risk Shifting with Fuzzy Capital Constraints," International Journal of Central Banking, International Journal of Central Banking, vol. 11(1), pages 71-101, January.
    12. Philip Lowe & Claudio Borio, 2002. "Asset prices, financial and monetary stability: exploring the nexus," BIS Working Papers 114, Bank for International Settlements.
    13. Atkinson, Tyler & Luttrell, David & Rosenblum, Harvey, 2013. "How bad was it? The costs and consequences of the 2007–09 financial crisis," Staff Papers, Federal Reserve Bank of Dallas, issue Jul.
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