Bubbly Recessions

Biswas, Siddhartha; Hanson, Andrew; Phan, Toan

Working Paper

Bubbly Recessions

Abstract: We develop a tractable rational bubbles model with financial frictions, downward nominal wage rigidity, and the zero lower bound. The interaction of financial frictions and nominal rigidities leads to a \"bubbly pecuniary externality,\" where competitive speculation in risky bubbly assets can result in excessive investment booms that precede inefficient busts. The collapse of a large bubble can push the economy into a \"secular stagnation\" equilibrium, where the zero lower bound and the nominal wage rigidity constraint bind, leading to a persistent and inefficient recession. We evaluate a macroprudential leaning-against-the-bubble policy that balances the trade-off between the booms and busts of bubbles.

Keywords: recessions; bubbles; secular stagnation;

JEL Classification: E10; E21; E40; E44;