Bubbly Recessions

56 Pages Posted: 5 Mar 2018 Last revised: 7 Apr 2018

Siddhartha Biswas

University of North Carolina (UNC) - Chapel Hill

Andrew Hanson

University of North Carolina (UNC) at Chapel Hill

Toan Phan

Federal Reserve Banks - Federal Reserve Bank of Richmond

Date Written: 2018-02-22

Abstract

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

Biswas, Siddhartha and Hanson, Andrew and Phan, Toan, Bubbly Recessions (2018-02-22). FRB Richmond Working Paper No. 18-5. Available at SSRN: https://ssrn.com/abstract=3133563

Siddhartha Biswas (Contact Author)

University of North Carolina (UNC) - Chapel Hill ( email )

107 Gardner Hall, CB 3305
University of North Carolina
Chapel Hill, NC 27599
United States

Andrew Hanson

University of North Carolina (UNC) at Chapel Hill ( email )

102 Ridge Road
Chapel Hill, NC NC 27514
United States

Toan Phan

Federal Reserve Banks - Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

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