PhD Lunch Seminars Amsterdam

Myrna Hennequin (University of Amsterdam)
Tuesday, 6 June 2017

Managing Coordination on Bubbles in Experimental Asset Markets with Monetary Policy

The frequent occurrence of large bubbles in asset pricing experiments raises a natural follow-up question: can these markets be stabilized with monetary policy? A “leaning against the wind” policy reacts to asset price bubbles by increasing the interest rate. But the way in which expectations are formed is crucial for the transmission of monetary policy. We conduct a learning-to-forecast experiment with a Taylor-type interest rate rule to study the interactions between interest rate policy, individual expectations and asset price bubbles. Our results indicate that a weak interest rate response is not able to prevent the formation of large bubbles. In contrast, bubbles are absent or remain small in markets with a strong interest rate response. Informing participants about the goal of the interest rate policy seems to work even more stabilizing. When the central bank does not know the steady state price and uses the sample average price as a proxy, the policy is less effective. (Joint with Cars Hommes)