Asriyan, VladimirFornaro, LucaMartin, Alberto, 1974-Ventura, Jaume2021-03-232021-03-232020Asriyan V, Fornaro L, Martin A, Ventura J. Monetary policy for a bubbly world. Rev Econ Stud. 2020 Aug 6;88(3):1418-56. DOI: 10.1093/restud/rdaa0450034-6527http://hdl.handle.net/10230/46899What is the role of monetary policy in a bubbly world? To address this question, we study an economy in which financial frictions limit the supply of assets. The ensuing scarcity generates a demand for “unbacked” assets, i.e., assets that are backed only by the expectation of their future value. We consider two types of unbacked assets: bubbles, which are created by the private sector, and money, which is created by the central bank. Bubbles and money share many features, but they also differ in two crucial respects. First, while the rents from the creation of bubbles accrue to entrepreneurs and foster investment, the rents from money creation accrue to the central bank. Second, while bubbles are driven by market psychology, and can rise and fall according to the whims of the market, money is under the control of the central bank. We characterize the optimal monetary policy and show that, through its ability to supply assets, monetary policy plays a key role in the bubbly world. The model sheds light on the recent expansion of central bank liabilities in response to the bursting of bubbles.application/pdfengThis is an Open Access article distributed under the terms of the Creative Commons Attribution Non-Commercial License (http://creativecommons.org/licenses/by-nc/4.0/), which permits non-commercial re-use, distribution, and reproduction in any medium, provided the original work is properly citedinfo:eu-repo/semantics/articlehttp://dx.doi.org/10.1093/restud/rdaa045Financial frictionsOptimal monetary policyLiquidity trapinfo:eu-repo/semantics/openAccess