Monetary policy and herd behavior in new-tech investment

This paper studies the interaction between monetary policy and asset prices using a simple general equilibrium model in which asset-price bubbles may form due to herd behavior in investment in a new technology whose productivity is uncertain. The economy is populated with one infinitely lived representative household and overlapping generations of finitely lived entrepreneurs. Entrepreneurs receive private signals about the productivity of the new technology and borrow from the household to publicly invest in the old or the new technology. Monetary policy intervention, by affecting the cost of resources for entrepreneurs, can make the entrepreneurs invest in the new technology if and only if they have received a favourable private signal. In doing so, it reveals this signal and hence prevents herd behavior and the asset-price bubble. We identify conditions under which such a monetary policy intervention is socially desirable.