Monetary Policy and Herd Behavior: Leaning Against Bubbles

Olivier Loisel, Aude Pommeret () and Franck Portier ()

Working papers from Banque de France

Abstract: We study the role of monetary policy when asset-price bubbles may form due to herd behavior in investment in an asset whose return is uncertain. To that aim, we build a simple general-equilibrium model whose agents are households, entrepreneurs, and a central bank. Entrepreneurs receive private signals about the productivity of the new technology and borrow from households to publicly invest in the old or the new technology. The three main results of the paper are that bubbles (informational cascades) can occur in this general equilibrium setting; that the central bank can detect them even though it has directly access to less information than the investors; and that the central bank can eliminate bubbles by manipulating the interest rate. Indeed, monetary policy, by affecting the investors' cost of resources, can make them invest in the new technology if and only if they receive an encouraging private signal about its productivity. In doing so, it makes their investment decision reveal their private signal, and therefore prevents herd behavior and the asset-price bubble. We also show that such a leaning against the wind" monetary policy, contingent on the central bank's information set, may be preferable to laisser-faire, in terms of ex ante welfare.

Keywords: Monetary; Policy; Asset; Prices; Informational; Cascades; Bubbles. (search for similar items in EconPapers)
JEL-codes: E32 E52 (search for similar items in EconPapers)
Pages: 58 pages
Date: 2012
New Economics Papers: this item is included in nep-cta, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (15)

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Working Paper: Monetary Policy and Herd Behavior: Leaning Against Bubbles (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:bfr:banfra:412

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