() and Tore Ellingsen
David Domeij: Dept. of Economics, Postal: Stockholm School of Economics, P.O. Box 6501, SE-113 83 Stockholm, Sweden
Tore Ellingsen: Dept. of Economics, Postal: Stockholm School of Economics, P.O. Box 6501, SE-113 83 Stockholm, Sweden
Abstract: We extend the Bewley-Aiyagari-Huggett model by incorporating an incomplete stock market and a persistent income process. In this quantitative general equilibrium framework, non-fundamental asset values are both large and desirable for realistic parameter values. However, if expectations shift from one equilibrium to another, some markets may crash as others soar. In the presence of nominal assets and contracts, such movements can be highly detrimental. Our analysis is consistent with the view that some of the world’s large recessions were caused by an avoidable failure of monetary and fiscal policy to prevent deflation in the aftermath of bursting asset price bubbles.
49 pages, February 13, 2015
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