Asset Price Bubbles with Low Interest Rates: Not All Bubbles are Likely to Emerge

Abstract

Leveraged asset price bubbles, i.e., boom-bust phases in asset prices accompanied by credit overhangs, are more harmful than unleveraged ones, in terms of nancial and macroeconomic stability. If bubbles are not all alike, neither are all bubbles likely? As bubbles are dicult to detect in real-time data, early researches focused on the macroeconomic conditions exacerbating the bubbles' nature. We specically look at a condition that could become more persistent in the aftermath of Covid-19 pandemic: low risk-free interest rates. In an OLG model, we show that the existence condition for a leveraged bubble is more easily met than that of an unleveraged bubble with low interest rates, and thus leveraged bubbly episodes are relatively more likely to emerge than unleveraged ones. Then, we show that this result holds empirically for post-World War II bubbles in advanced economies.

Asset Price Bubbles and Monetary Policy: Revisiting the Nexus at the Zero Lower Bound

“…The central bank maneuvers the nominal interest rate i t to track the natural interest rate r f t , which is consistent with potential output (Y f =L α ) and inflation at the targeted level Π * (Cúrdia et al, 2015). However, if the natural interest rate turns negative (1 + r f t < 1) and the targeted inflation rate is not sufficiently high, the central bank would set a negative nominal interest rate but it cannot because of the ZLB in equation (11). Finally, the gross real interest rate has to satisfy the Fisher condition…”

“…As these two effects push r f t up by shifting the credit supply curve left and the credit demand curve right, the natural rate of interest is higher in a bubbly economy. 11 This result will be crucial in the next sections, in which I will study the effect of a permanent change to r f t .…”

“…For γΠ * > 1 and γ < 1, a special case emerges if 1 + rf < 1 and 1/(1 + r f ) < Π * < 1/γ(1 + r f ) (Ascariand Bonchi, 2019). In this case, the unleveraged bubble makes a FEB to arise, along with a bubbly equilibrium with full employment and binding ZLB, but the LIR survives.…”

Asset price bubbles and monetary policy: Revisiting the nexus at the zero lower bound

“…The central bank maneuvers the nominal interest rate i t to track the natural interest rate r f t , which is consistent with potential output (Y f = Lα ) and inflation at the targeted level Π * (Cúrdia et al, 2015). However, if the natural interest rate turns negative (1 + r f t < 1) and the targeted inflation rate is not sufficiently high, the central bank would set a negative nominal interest rate but it cannot because of the ZLB in equation (11). Finally, the gross real interest rate has to satisfy the Fisher condition…”

“…As these two effects push r f t up by shifting the credit supply curve left and the credit demand curve right, the natural rate of interest is higher in a bubbly economy. 11 This result will be crucial in the next sections, in which I 11 I deliberately isolate the redistributive effect of asset price bubbles from any other one, in particular from that affecting will study the effect of a permanent change to r f t .…”