Asset price bubbles with low interest rates: not all bubbles are alike

Jacopo Bonchi

No wp2019-01, Bank of Estonia Working Papers from Bank of Estonia

Abstract: I extend a standard two-period OLG model to investigate the interplay between the risks of a binding zero lower bound and asset price bubbles in a low interest rates environment. The nature of the bubble is crucial when the risk-free real interest rate is low because there is a negative natural interest rate. Bubbles are fully leveraged when they are sustained by borrowers, or they are fully unleveraged when they are sustained by lenders. Leveraged bubbles emerge naturally when there is a negative natural interest rate, and they are more likely to collapse. Unleveraged bubbles appear, in contrast, if the natural rate of interest is extremely low and the probability of the bubble bursting is not extremely high. Both bubbles are more likely to emerge with a high inflation target and will potentially be larger, but only leveraged bubbles substantially mitigate the risk of a zero lower bound episode by raising the natural rate of interest

Keywords: zero lower bound; low interest rates; asset price bubbles; inflation target (search for similar items in EconPapers)
JEL-codes: E43 E44 E52 (search for similar items in EconPapers)
Date: 2019-01-23, Revised 2019-01-23
New Economics Papers: this item is included in nep-cba, nep-dge and nep-mac
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Citations: View citations in EconPapers (2)

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