Deflating asset price bubbles with leverage constraints and monetary policy

This paper studies the interaction of labor, goods, and asset markets in experimental macroeconomies populated by household investors. We analyze the aggregate effects of two different policies intended to stabilize asset prices: leverage constraints and a `leaning against the wind' monetary policy that raises interest rates in response to asset price inflation. We find that introducing a leverage constraint significantly reduces asset prices when the constraint actually binds. Households often circumvent these constraints by excessively supplying labor and generating increased wealth which can be used for speculation. As a result, asset price deviations are significantly higher under a policy regime of leverage constraints. Raising interest rates according to a `leaning against the wind' policy effectively contracts asset prices with minimal impact on production. Our experimental findings suggest that asset inflation targeting is more effective than leverage constraints at stabilizing asset price.