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Natural Interest Rate and Asset Price Bubbles: How Bubbles Counteract Low Interest Rates

Jacopo Bonchi

No 3/20, Working Papers from Sapienza University of Rome, DISS

Abstract: By developing a three-period OLG model with rational asset price bubbles and non-neutral monetary policy, I show how bubbles prevent low interest rates, when the natural rate of interest declines permanently. Bubbles push the natural interest rate up by serving as store of value (saving channel) and collateral (borrowing channel), and this avoids a long-lasting ZLB episode. Bubbles reallocate resources across generations too, and this reallocation implies welfare losses. These results shed light on the pattern of the US risk-free interest rates and on that of net worth and consumption across generations before the Great Recession.

Keywords: Asset price bubbles; Natural interest rate; Zero lower bound (search for similar items in EconPapers)
JEL-codes: E13 E32 E44 E52 (search for similar items in EconPapers)
Date: 2020-02
New Economics Papers: this item is included in nep-dge and nep-mac
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