Monetary Policy for a Bubbly World

Money and Capital in a Persistent Liquidity Trap

Vladimir Asriyan, Luca Fornaro, Alberto Martin and Jaume Ventura

The Review of Economic Studies, 2021, vol. 88, issue 3, 1418-1456

Abstract: What is the role of monetary policy in a bubbly world? To address this question, we study an economy in which financial frictions limit the supply of assets. The ensuing scarcity generates a demand for “unbacked” assets, i.e., assets that are backed only by the expectation of their future value. We consider two types of unbacked assets: bubbles, which are created by the private sector, and money, which is created by the central bank. Bubbles and money share many features, but they also differ in two crucial respects. First, while the rents from the creation of bubbles accrue to entrepreneurs and foster investment, the rents from money creation accrue to the central bank. Second, while bubbles are driven by market psychology, and can rise and fall according to the whims of the market, money is under the control of the central bank. We characterize the optimal monetary policy and show that, through its ability to supply assets, monetary policy plays a key role in the bubbly world. The model sheds light on the recent expansion of central bank liabilities in response to the bursting of bubbles.

Keywords: Bubbles; Financial frictions; Optimal monetary policy; Liquidity trap; E32; E44; O40 (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (15)

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Related works:
Working Paper: Monetary policy for a bubbly world (2020)
Working Paper: Monetary Policy for a Bubbly World (2019)
Working Paper: Monetary Policy for a Bubbly World (2016)
Working Paper: Monetary Policy for a Bubbly World (2016)
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