Deflating asset price bubbles with leverage constraints and monetary policy

Guidon Fenig, Mariya Mileva and Luba Petersen

Journal of Economic Behavior & Organization, 2018, vol. 155, issue C, 1-27

Abstract: We develop an experimental production economy to study the general equilibrium and welfare effects of speculation and stabilization policies. Participants playing the role of household-investors interact in labor, output, and, in some treatments, asset markets. Without the ability to trade assets, participants over-supply costly labor to acquire saving. The presence of asset markets improves welfare by allowing investors to substitute labor income for speculative gains. Asset prices deviate substantially from fundamental value. Leverage constraints that prevent investors from borrowing for speculation are ineffective at stabilizing asset prices. Households often circumvent the constraints by excessively supplying labor and generating increased wealth which can be used for speculation. Wealth inequality is worsened due to endogenously higher interest accumulated by borrowers and savers. An asset inflation targeting policy fuels initial asset price growth but, as interest rates rise rapidly, effectively deflates asset price deviations. With learning, the policy stabilizes asset prices and consequently interest rates, which enhances welfare and reduces inequality. We develop a model of heterogeneous expectations to rationalize our experimental findings.

Keywords: Experimental macroeconomics; Laboratory experiment; Monetary policy; Asset price bubbles; General equilibrium; Production economy; Leverage; Heterogeneous expectations (search for similar items in EconPapers)
JEL-codes: C92 D91 E21 E52 (search for similar items in EconPapers)
Date: 2018
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (19)

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Working Paper: Deflating asset price bubbles with leverage constraints and monetary policy (2017)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jeborg:v:155:y:2018:i:c:p:1-27

DOI: 10.1016/j.jebo.2018.06.021

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