Optimal Macroprudential Policy and Asset Price Bubbles
45 Pages Posted: 23 Sep 2019
Date Written: August 2019
An asset bubble relaxes collateral constraints and increases borrowing by credit-constrained agents. At the same time, as the bubble deflates when constraints start binding, it amplifies downturns. We show analytically and quantitatively that the macroprudential policy should optimally respond to building asset price bubbles non-monotonically depending on the underlying level of indebtedness. If the level of debt is moderate, policy should accommodate the bubble to reduce the incidence of a binding collateral constraint. If debt is elevated, policy should lean against the bubble more aggressively to mitigate the pecuniary externalities from a deflating bubble when constraints bind.
Keywords: Economic conditions, Financial crises, Demand, Economic stabilization, Price indexes, Collateral constraints, rational bubbles, macroprudential regulation, optimal policy, WP, asset price bubble, overvaluation, asset price, Euler equation, bubble
JEL Classification: E2, E44, G2, G1, E01, G12, E52, E63, O4
Suggested Citation: Suggested Citation