Rational bubbles and macroeconomic fluctuations: The (de-)stabilizing role of monetary policy

We are interested in the occurrence of expectation-driven fluctuations of a rational bubble and the (de-)stabilizing role of monetary policy. Our explanation of fluctuations is based on credit market imperfections. For this purpose, we consider an overlapping generations exchange economy where households realize a portfolio choice between money and bubble. Money is held because of a partial cash-in-advance constraint affected by the bubble. Bubble acts as a store of value, but also as a collateral. Indeed, a higher value of the bubble implies a higher amount of collateral, which, in turn, reduces the need of cash, and thus increases consumption purchased on credit. Under these credit market features, expectation-driven fluctuations and the multiplicity of steady-states occur, in particular for arbitrarily small market distortions. Investing the stabilizing role of monetary policy, we show that when the monetary policy rule depends on expected inflation only, a more active rule stabilizes only if collateral has a large effect on consumption financed on credit. Finally, we enrich this rule by including asset prices. A policy which depends on asset prices can stabilize whatever the effect of collateral and can also rule out the multiplicity of steady states. More generally, this paper emphasizes the ∗We would like to thank Edouard Challe, Jean-Michel Grandmont, Takashi Kamihigashi, Hubert Kempf, Olivier Loisel, Carine Nourry, Yiannis Vailakis, Alain Venditti and Bertrand Wigniolle for useful suggestions. We also thank participants to the Bilkent University macroeconomic seminar, to the Conference in honor of Cuong Le Van held in University Paris 1 on December 2011, to the workshop OLG Days held in Aix-Marseille University on May 2012, to the Conference PET 2012, to the Conference 11th “Journées Louis-André Gérard-Varet”, to the Conference SAET 2012. Any remaining errors are our own. †Corresponding author. Aix-Marseille University (Aix-Marseille School of Economics), CNRS-GREQAM and EHESS, Centre de la Vieille Charité, 2 rue de la Charité, 13236 Marseille CEDEX 02, France. E-mail: [email protected]. ‡Aix-Marseille University (Aix-Marseille School of Economics), CNRS-GREQAM and EHESS, Centre de la Vieille Charité, 2 rue de la Charité, 13236 Marseille CEDEX 02, France. E-mail: [email protected]. 1 ha ls hs -0 07 93 06 3, v er si on 2 17 M ay 2 01 3 key role of consumers’ credit market imperfections to explain bubble fluctuations and exhibits the stabilizing power of monetary rules including asset prices. JEL classification: D91, E32, E52.