Working Paper: CEPR ID: DP10528
Authors: Markus K. Brunnermeier; Isabel Schnabel
Abstract: This paper reviews some of the most prominent asset price bubbles from the past 400 years and documents how central banks (or other institutions) reacted to those bubbles. The historical evidence suggests that the emergence of bubbles is often preceded or accompanied by an expansionary monetary policy, lending booms, capital inflows, and financial innovation or deregulation. We find that the severity of the economic crisis following the bursting of a bubble is less linked to the type of asset than to the financing of the bubble?crises are most severe when accompanied by a lending boom and high leverage of market players, and when financial institutions themselves are participating in the buying frenzy. Past experience also suggests that a purely passive ?cleaning up the mess? stance toward the buildup of bubbles is, in many cases, costly. Monetary policy and macroprudential measures that lean against inflating bubbles can and sometimes have helped deflate bubbles and mitigate the associated economic crises. However, the correct implementation of such proactive policy approaches remains fraught with difficulties.
Keywords: bubbles; capital flows; credit; macroprudential policy; monetary policy
JEL Codes: E44; E52; F34; G01; N10
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| expansionary monetary policy (E52) | emergence of asset price bubbles (E32) |
| lending booms (F65) | emergence of asset price bubbles (E32) |
| capital inflows (F21) | emergence of asset price bubbles (E32) |
| financial innovation (O16) | emergence of asset price bubbles (E32) |
| high leverage (G19) | severity of crises following bursting of a bubble (G01) |
| lending booms (F65) | severity of crises following bursting of a bubble (G01) |
| passive policy approach (E63) | severity of crises following bursting of a bubble (G01) |
| leaning monetary policy (E52) | mitigation of crises (H12) |
| timing of macroprudential measures (E60) | effectiveness of macroprudential measures (E44) |