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Only Paul Could Go To Changchun

Deflating asset price bubbles with leverage constraints and monetary policy

7/23/2018

 
Here.

This paper studies the interaction of labor, goods, and asset markets in experimental macroeconomies populated by household investors. We analyze the aggregate effects of two different policies intended to stabilize asset prices: leverage constraints and a ‘leaning against the wind’ monetary policy that raises interest rates in response to asset price inflation. While models based on rational expectations predict that the asset will be priced at its constant fundamental value, a heterogeneous model of expectations predicts that both policies would reduce asset price volatility. We find that introducing a binding leverage constraint is ineffective at stabilizing asset prices. Households often circumvent these constraints by excessively supplying labor and generating increased wealth which can be used for speculation. As a result, asset price deviations are significantly higher under a policy regime of leverage constraints. A ‘leaning against the wind’ policy makes asset prices more sensitive to nominal interest rates changes and reduces the persistence of asset prices. 

From:

Guidon Fenig
University of Saskatchewan

Mariya Mileva
California State University

Luba Petersen
Simon Fraser University

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