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Working Paper
Bubbly Recessions
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.
AUTHORS: Hanson, Andrew; Phan, Toan; Biswas, Siddhartha
DATE: 2018-02-22