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Asset Price Bubbles and Monetary Policy

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  • Franklin Allen
  • Douglas Gale

Abstract

Positive and negative asset price bubbles and their relationship to monetary policy are considered. Positive bubbles occur when there is an agency problem between banks and the people they lend money to because the banks cannot observe how the funds are invested. This causes a risk shifting problem and asset prices are bid up above their fundamental. The greater is uncertainty concerning monetary policy and the amount of aggregate credit the greater is the bubble. Negative bubbles can occur when there is a banking crisis that forces banks to simultaneously liquidate assets. Asset prices fall below their fundamental because of a lack of liquidity. If the central bank provides a monetary injection this negative bubble can be prevented.

Suggested Citation

  • Franklin Allen & Douglas Gale, 2000. "Asset Price Bubbles and Monetary Policy," Center for Financial Institutions Working Papers 01-26, Wharton School Center for Financial Institutions, University of Pennsylvania.
    • Handle: RePEc:wop:pennin:01-26
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    File URL: http://fic.wharton.upenn.edu/fic/papers/01/0126.pdf
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    Cited by:

    1. Topi, Jukka & Vilmunen, Jouko, 2001. "Transmission of monetary policy shocks in Finland: evidence from bank level data on loans," Working Paper Series 0100, European Central Bank.
    2. Bilge Kagan Ozdemir, 2009. "Banking Sector Stability During The Process Of Euro Adoption," Anadolu University Journal of Social Sciences, Anadolu University, vol. 9(1), pages 123-1236, June.
    3. Weber, Patrick, 2012. "Timing asset market peaks: the role of the liquidity risk cycle of the banking system," MPRA Paper 36061, University Library of Munich, Germany.
    4. Marcel Canoy & Machiel van Dijk & Jan Lemmen & Ruud de Mooij & Jürgen Weigand, 2001. "Competition and stability in banking," CPB Document 15.rdf, CPB Netherlands Bureau for Economic Policy Analysis.
    5. Indrani Manna, 2018. "Can We Still Lean Against the Wind?," Open Economies Review, Springer, vol. 29(2), pages 223-259, April.
    6. Barlevy, Gadi, 2014. "A leverage-based model of speculative bubbles," Journal of Economic Theory, Elsevier, vol. 153(C), pages 459-505.
    7. Alexandros Kontonikas & Alberto Montagnoli, 2006. "Optimal Monetary Policy And Asset Price Misalignments," Scottish Journal of Political Economy, Scottish Economic Society, vol. 53(5), pages 636-654, November.
    8. Yong Ma & Yulu Chen, 2014. "Financial Imbalance Index as a New Early Warning Indicator: Methods and Applications in the Chinese Economy," China & World Economy, Institute of World Economics and Politics, Chinese Academy of Social Sciences, vol. 22(6), pages 64-86, November.
    9. Illing, Gerhard, . "Financial Fragility, Bubbles and Monetary Policy," Chapters in Economics,, University of Munich, Department of Economics.
    10. Jakas, Vicente, 2011. "Theory and empirics of an affine term structure model applied to European data," MPRA Paper 36029, University Library of Munich, Germany.
    11. Marcel Canoy & Machiel van Dijk & Jan Lemmen & Ruud de Mooij & Jürgen Weigand, 2001. "Competition and stability in banking," CPB Document 15, CPB Netherlands Bureau for Economic Policy Analysis.
    12. Bhupal Singh, 2022. "Housing and stock market wealth effects in developing economies," International Economics and Economic Policy, Springer, vol. 19(1), pages 29-49, February.
    13. Giovanni Dell'Ariccia & Karl Habermeier & Vikram Haksar & Tommaso Mancini-Griffoli, 2017. "Monetary Policy and Financial Stability," RBA Annual Conference Volume (Discontinued), in: Jonathan Hambur & John Simon (ed.),Monetary Policy and Financial Stability in a World of Low Interest Rates, Reserve Bank of Australia.
    14. Siklos, Pierre L. & Bohl, Martin T. & Werner, Thomas, 2003. "Did the Bundesbank React to Stock Price Movements?," Discussion Paper Series 1: Economic Studies 2003,14, Deutsche Bundesbank.
    15. Brousseau, Vincent & Detken, Carsten, 2001. "Monetary policy and fears of financial instability," Working Paper Series 89, European Central Bank.

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