56 Pages Posted: 5 Mar 2018 Last revised: 7 Apr 2018
Date Written: 2018-02-22
We develop a tractable rational bubbles model with financial frictions, downward nominal wage rigidity, and the zero lower bound. The interaction of financial frictions and nominal rigidities leads to a "bubbly pecuniary externality," where competitive speculation in risky bubbly assets can result in excessive investment booms that precede inefficient busts. The collapse of a large bubble can push the economy into a "secular stagnation" equilibrium, where the zero lower bound and the nominal wage rigidity constraint bind, leading to a persistent and inefficient recession. We evaluate a macroprudential leaning-against-the-bubble policy that balances the trade-off between the booms and busts of bubbles.
Keywords: recessions, bubbles, secular stagnation
JEL Classification: E10, E21, E40, E44
Suggested Citation: Suggested Citation