Monetary Policy for a Bubbly World

49 Pages Posted: 20 Sep 2016 Last revised: 10 Jun 2019

See all articles by Vladimir Asriyan

Vladimir Asriyan

CREI; Barcelona GSE; Universitat Pompeu Fabra; Centre for Economic Policy Research (CEPR)

Luca Fornaro

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI); Barcelona Graduate School of Economics (Barcelona GSE)

Alberto Martin

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI); Centre for Economic Policy Research (CEPR)

Jaume Ventura

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI)

Multiple version iconThere are 3 versions of this paper

Date Written: July 1, 2016

Abstract

What is the role of monetary policy in a bubbly world? To address this question, we study an economy in which financial frictions limit the supply of assets. The ensuing scarcity generates a demand for ``unbacked" assets, i.e., assets that are backed only by the expectation of their future value. We consider two types of unbacked assets: bubbles, which are created by the private sector, and money, which is created by the central bank. Bubbles and money share many features, but they also differ in two crucial respects. First, while the rents from the creation of bubbles accrue to entrepreneurs and foster investment, the rents from money creation accrue to the central bank. Second, while bubbles are driven by market psychology, and can rise and fall according to the whims of the market, money is under the control of the central bank. We characterize the optimal monetary policy and show that, through its ability to supply assets, monetary policy plays a key role in the bubbly world. The model sheds light on the recent expansion of central bank liabilities in response to the bursting of bubbles.

Keywords: bubbles; financial frictions; optimal monetary policy; liquidity trap

JEL Classification: E32; E44; O40

Suggested Citation

Asriyan, Vladimir and Fornaro, Luca and Martin, Alberto and Ventura, Jaume, Monetary Policy for a Bubbly World (July 1, 2016). Available at SSRN: https://ssrn.com/abstract=2840723 or http://dx.doi.org/10.2139/ssrn.2840723

Vladimir Asriyan (Contact Author)

CREI ( email )

Ramon Trias Fargas, 25-27
Barcelona, 08005
Spain

HOME PAGE: http://crei.cat/people/asriyan/welcome.html

Barcelona GSE ( email )

Ramon Trias Fargas, 25-27
Barcelona, Barcelona 08005
Spain

HOME PAGE: http://www.barcelonagse.eu/Faculty.php?id=510

Universitat Pompeu Fabra ( email )

Ramon Trias Fargas, 25-27
Barcelona, E-08005
Spain

HOME PAGE: http://www.econ.upf.edu/en/people/onefaculty.php?id=p7040

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Luca Fornaro

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI) ( email )

Ramon Trias Fargas, 25-27
Barcelona, 08005
Spain

Barcelona Graduate School of Economics (Barcelona GSE) ( email )

Ramon Trias Fargas, 25-27
Barcelona, Barcelona 08005
Spain

Alberto Martin

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI) ( email )

Ramon Trias Fargas, 25-27
Barcelona, 08005
Spain

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Jaume Ventura

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI) ( email )

Ramon Trias Fargas, 25-27
Barcelona, 08005
Spain

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