XXVI Edition

14-15-16 December 2017"

Deleveraging, Stock Market Bubbles and Monetary Policy

ROVO NATASHA, LUISS Guido Carli and CASMEF

By means of an estimated vector-autoregression model I provide empirical evidence on the response of stock market prices to a deleveraging shock, and I show that the response is almost entirely explained by the bubbly component of stock prices. I propose an OLG model and I show that the existence of bubbles is welfare improving and depends on financial constraints. However, under perfect foresight, the equilibrium dynamics are not stationary. Monetary policy, by adopting an accommodative stance towards bubbles, can ensure the stability of the bubbly steady state and the stationarity of the dynamics around it. If agents have static expectations, monetary policy can deliver an expansion in output, led by the growth in the bubble, though at the cost of a greater volatility than under benign neglect.

Area: Monetary Policy and Central Banking

Keywords: Bubbles, Monetary Policy, Deleveraging, Secular Stagnation

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