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Should Central Banks Prick Asset Price Bubbles? An Analysis Based on a Financial Accelerator Model with an Agent-Based Financial Market

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  • Alexey Vasilenko

    (Bank of Russia, Russian Federation;National Research University Higher School of Economics, Laboratory for Macroeconomic Analysis; University of Toronto, Joseph L Rotman School of Management.)

Abstract

This paper studies whether and how the central bank should prick asset price bubbles, if the effect of interest rate policy on bubbles can significantly vary across periods. For this purpose, I first construct a financial accelerator model with an agent-based financial market that can endogenously generate bubbles and account for their impact on the real sector of the economy. Then, I calculate the effect of different nonlinear interest rate rules for pricking asset price bubbles on social welfare and financial stability. The results demonstrate that pricking asset price bubbles can enhance social welfare and reduce the volatility of output and inflation, especially if asset price bubbles are caused by credit expansion. Pricking bubbles is also desirable when the central bank can additionally implement an effective communication policy to prick bubbles, for example, effective verbal interventions aimed at the expectations of agents in the financial market.

Suggested Citation

  • Alexey Vasilenko, 2018. "Should Central Banks Prick Asset Price Bubbles? An Analysis Based on a Financial Accelerator Model with an Agent-Based Financial Market," Bank of Russia Working Paper Series wps35, Bank of Russia.
    • Handle: RePEc:bkr:wpaper:wps35
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    More about this item

    Keywords

    monetary policy; asset price bubble; New Keynesian macroeconomics; agent-based financial market.;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G01 - Financial Economics - - General - - - Financial Crises
    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles

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