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Does a low interest rate support private bubbles?

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  • Benjamin Eden

    () (Department of Economics, Vanderbilt University)

Abstract

I examine the argument that a low interest rate policy can lead to "overvalued" private assets or privately created bubbles (private bubbles). Using the standard approach to bubbles, I find that a policy of a low real interest rate may support private bubbles but a policy of a low nominal interest rate may actually reduce the importance of private bubbles. I then attempt a less conventional way of modeling bubbles focusing on the supply of private bubbles. The paper uses results from the Friedman rule literature, the fiscal approach to the price level and the literature on rational bubbles.

Suggested Citation

  • Benjamin Eden, 2012. "Does a low interest rate support private bubbles?," Vanderbilt University Department of Economics Working Papers 12-00010, Vanderbilt University Department of Economics.
  • Handle: RePEc:van:wpaper:vuecon-12-00010
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    References listed on IDEAS

    as
    1. Ben S. Bernanke & Mark Gertler, 2001. "Should Central Banks Respond to Movements in Asset Prices?," American Economic Review, American Economic Association, vol. 91(2), pages 253-257, May.
    2. Paul A. Samuelson, 1958. "An Exact Consumption-Loan Model of Interest with or without the Social Contrivance of Money," Journal of Political Economy, University of Chicago Press, vol. 66, pages 467-467.
    3. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February.
    4. Sims, Christopher A, 1994. "A Simple Model for Study of the Determination of the Price Level and the Interaction of Monetary and Fiscal Policy," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 4(3), pages 381-399.
    5. Narayana R. Kocherlakota, 2010. "Taxing risk and the optimal regulation of financial institutions," Economic Policy Paper 10-3, Federal Reserve Bank of Minneapolis.
    6. Dupor, Bill, 2000. "Exchange rates and the fiscal theory of the price level," Journal of Monetary Economics, Elsevier, vol. 45(3), pages 613-630, June.
    7. Cochrane, John H, 2001. "Long-Term Debt and Optimal Policy in the Fiscal Theory of the Price Level," Econometrica, Econometric Society, pages 69-116.
    8. George A. Akerlof, 1970. "The Market for "Lemons": Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, Oxford University Press, vol. 84(3), pages 488-500.
    9. Olivier J. Blanchard & Mark W. Watson, 1982. "Bubbles, Rational Expectations and Financial Markets," NBER Working Papers 0945, National Bureau of Economic Research, Inc.
    10. Tirole, Jean, 1985. "Asset Bubbles and Overlapping Generations," Econometrica, Econometric Society, vol. 53(6), pages 1499-1528, November.
    11. Sargent, Thomas J & Wallace, Neil, 1982. "The Real-Bills Doctrine versus the Quantity Theory: A Reconsideration," Journal of Political Economy, University of Chicago Press, vol. 90(6), pages 1212-1236, December.
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    More about this item

    Keywords

    Interest Rate Policy; The Friedman Rule; The Fiscal Approach to Bubbles.;

    JEL classification:

    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates

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