Bubbles and Stagnation

Inês Xavier
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Inês Xavier: https://www.federalreserve.gov/econres/ines-m-xavier.htm

No 2022-033, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: This paper studies the consequences of asset bubbles for economies that are vulnerable to persistent stagnation. Stagnation is the result of a shortage of assets that creates an oversupply of savings and puts downward pressure on the level of interest rates. Once the zero lower bound on the nominal interest rate binds, the real rate cannot fully adjust downward, forcing output to fall instead. In such context, bubbles are useful as they expand the supply of assets, absorb excess savings and raise the natural interest rate - the real rate that is compatible with full employment - crowding in consumption and raising welfare. While safe bubbles are more likely to expand economic activity, riskier bubbles command a risk premium that, in equilibrium, lowers the real interest rate. A lower rate loosens borrowing constraints, potentially improving welfare when financing conditions are especially tight. Finally, fiscal policy that promises a bail-out transfer in case of a bubble collapse can support an existing bubble and improve welfare.

Keywords: Bubbles; Secular stagnation; Liquidity traps (search for similar items in EconPapers)
JEL-codes: E31 E32 E43 E44 G11 (search for similar items in EconPapers)
Pages: 32 p.
Date: 2022-05-31
New Economics Papers: this item is included in nep-cba, nep-dge, nep-fdg and nep-mac
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2022-33

DOI: 10.17016/FEDS.2022.033

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