Working Paper: NBER ID: w22639
Authors: Vladimir Asriyan; Luca Fornaro; Alberto Martin; Jaume Ventura
Abstract: We propose a model of money, credit and bubbles, and use it to study the role of monetary policy in managing asset bubbles. In this model, bubbles pop up and burst, generating fluctuations in credit, investment and output. Two key insights emerge from the analysis. First, the growth rate of bubbles, which is driven by agents’ expectations, can be set in real or in nominal terms. This gives rise to a novel channel of monetary policy, as changes in the inflation rate affect the real growth rate of bubbles and their effect on economic activity. Crucially, this channel does not rely on contract incompleteness or price rigidities. Second, there is a natural limit on monetary policy’s ability to control bubbles: the zero-lower bound. When a bubble crashes, the economy may enter into a liquidity trap, a regime in which agents shift their portfolios away from bubbles - and the credit that they sustain - to money, reducing intermediation, investment and growth. We explore the implications of the model for the conduct of “conventional” and “unconventional” monetary policy, and we use the model to provide a broad interpretation of salient macroeconomic facts of the last two decades.
Keywords: monetary policy; asset bubbles; liquidity traps
JEL Codes: E32; E44; O40
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Changes in the inflation rate (E31) | Growth rate of bubbles (O42) |
| Growth rate of bubbles (O42) | Economic activity (E29) |
| Monetary policy influences the growth of bubbles (E52) | Economic activity (E29) |
| Bubble crashes (E32) | Liquidity trap (E41) |
| Liquidity trap (E41) | Reduction in credit and investment (O16) |
| Higher fraction of nominal contracts (G19) | Effectiveness of monetary policy (E52) |
| Monetary policy can stabilize investment and output (E63) | Economic stability (E60) |
| Monetary policy may destabilize credit markets (E44) | Complex trade-offs (F12) |